Reforming Insurance Contract Law

A Summary of Responses to Consultation

May 2008

This document summarises the responses on consumer issues to the Law Commissions’Consultation PaperInsurance Contract Law: misrepresentation, non-disclosure and breach of warranty by the insured.

CONTENTS

PART 1 : INTRODUCTION 1

Aim of this paper 1

Overview 1

Consultees' responses 2

Contents of this paper 3

Approach 4

Future work 4

Thanks 4

PART 2 : PRE-CONTRACT INFORMATION FROM CONSUMERS 5

Is there a need for reform? 5

Defining consumers 8

Abolishing consumers' duty to volunteer information 9

The basic requirements: misrepresentation and inducement 11

Deliberate or reckless misrepresentations 12

"Innocent" misrepresentations 17

A continuing duty of disclosure? 24

Negligent misrepresentations: a compensatory remedy 26

Claims that are unrelated to the misrepresentation 29

Is there a need for a judicial discretion? 30

Cancelling for the future 33

Negligent misrepresentations in life policies: should the law impose a cut off period? 33

No contracting out 34

PART 3: GROUP INSURANCE, CO-INSURANCE AND INSURANCE ON THE LIFEOF ANOTHER 36

Group insurance 36

Co-insurance 40

Insurance on the life of another 41

Consumer insurance: "joint lives, first death" policies 42

PART 4: WARRANTIES AS TO THE FUTURE 44

What is a warranty? A wide or narrow defintion 44

The limited effect of our proposals on consumer policies 46

The importance of the UTCCR 47

PART 5: PRE-CONTRACT INFORMATION AND INTERMEDIARIES 48

The problem 48

Is there a need for reform? 49

Should intermediaries be taken to act for insurers unless they are clearlyindependent? 53

Defining "independence": the "fair analysis" test 55

The way forward: overview 58

Intermediaries not regulated by the FSA 62

The Newsholme case 62

Marine Insurance Act 1906, section 19 63

PART 6 : ASSESSING THE COSTS AND BENEFITS OF REFORM 65

London Economics Report 65

Consultees' responses 65

Future work 66

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PART 1INTRODUCTION

AIM OF THIS PAPER 1.1 In July 2007, the Law Commission and the Scottish Law Commission published a

joint Consultation Paper on misrepresentation, non-disclosure and breach ofwarranty by the insured.1 It made provisional proposals and asked questions inrelation to both business and consumer insurance.

1.2 This document summarises the responses we received to that paper in relation toconsumers. It does not give the views of either Law Commission. Instead, it isissued with the purpose of reporting the arguments raised. It is, for the most part,a factual summary of the views put to us. The Law Commissions have not yetformulated their final recommendations on this subject.

OVERVIEW 1.3 There is a wide consensus that consumer insurance law is in urgent need of

reform. Support for reform was shown not only by consumer groups, brokers andlawyers, but also by insurers themselves. Of the 39 insurers and insuranceorganisations responding to our paper, only four argued against reform. Manyactively welcomed reform to make the law simpler and clearer. We were also toldthat reform would improve confidence in the industry.

1.4 In general, our provisional proposals followed the approach already taken by theFinancial Ombudsman Service (FOS). Most insurers supported enshrining theFOS approach into law by, for example, abolishing consumers’ legal duty tovolunteer information, protecting those who act honestly and reasonably, andproviding insurers with proportionate remedies for negligent misrepresentations.We therefore intend to draft new legislation to deal with consumers’ obligations togive pre-contractual information to insurers, and insurers’ remedies where theyfail to do so.

1.5 Given the support expressed for this reform, we are treating draft legislation todeal with pre-contract information from consumers as a priority. Therefore, weare publishing this summary of responses on consumer issues first. A furtherpaper will summarise the responses received to the business insuranceproposals.

1 Law Commission Consultation Paper No 182; Scottish Law Commission Discussion PaperNo 134.

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1.6 Our first Bill will be confined to the law on consumer pre-contract information. InPart 4, we explain why we intend to postpone reform of consumer futurewarranties and deal with them alongside the business reforms. The main reasonis that the need for reform is less pressing. Warranties in the strict legal senseare used only rarely in consumer insurance. And if they are used unfairly,consumers have remedies not only under the Financial Services Authority rulesbut also under the Unfair Terms in Consumer Contracts Regulations 1999.Furthermore, we think that the law on consumer future warranties should beconsistent with the law on business warranties.

1.7 Our provisional proposals on insurance intermediaries proved to be much morecontroversial than other aspects of the Consultation Paper. In Part 5, we reportthe criticisms made of our proposals on intermediaries and suggest possiblealternative approaches.

CONSULTEES’ RESPONSES 1.8 Since the Consultation Paper was published we have received 105 written

responses from consultees and attended over 50 meetings with buyers, insurers,brokers, lawyers and representative groups.

1.9 The table below shows the identities of those who submitted the 105 responseswe received.

Table 1: Respondents to the Consultation Paper, by categoryType of respondent Number

Insurers and insurance associations 39

Lawyers, legal associations and the judiciary 25

Brokers and brokers’ associations 13

Consumer insureds and consumer groups 7

Business insureds and trade associations 8

Academics 5

Other 8

Total 105

1.10 Several of those 105 consultees do not work in the consumer market andtherefore made comments only in relation to our proposals for businessinsurance. Between 60 and 70 respondents made comments on a substantialnumber of consumer proposals. We identified 63 respondents who addressedfour out of the first eight consumer questions in the paper – and we categorisethem in Table 2.

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Table 2: Respondents commenting on a substantial number of consumerproposals, by category

Type of respondent Number %

Insurers and insurance associations 28 44%

Lawyers, legal associations and the judiciary 17 27%

Brokers and brokers’ associations 7 11%

Consumer insureds and consumer groups 4 6%

Business insureds and trade associations 1 2%

Academics 2 3%

Other 4 6%

All 63 100%

CONTENTS OF THIS PAPER 1.11 This paper is divided into a further five parts. They follow the order set out in the

Consultation Paper.

(1) Part 2 looks at the overall scheme we are proposing for pre-contractinformation from consumers. It follows the questions discussed in Part 4of the Consultation Paper, and listed in paragraphs 12.1 to 12.25.

(2) Part 3 considers issues relating to pre-contract information in groupinsurance, co-insurance and insurance on the life of another. It followsthe questions discussed in Part 6 of the Consultation Paper, and listed inparagraphs 12.44 to 12.51.2

(3) Part 4 gives a brief indication of our approach to future warranties inrelation to consumers. Most of the proposals discussed in Parts 7 and 8of the Consultation Paper (and listed in paragraphs 12.53 to 12.69) relateprimarily to business insurance. We will therefore report on responses tothem in our second paper on business insurance to be published inSummer 2008.

(4) Part 5 deals with the role of intermediaries in communicating pre-contractinformation from consumers to insurers. These issues were discussed inParts 9 and 10 of the Consultation Paper, and listed in paragraphs 12.70to 12.77.

2 Question 12.52 relates only to business insurance, and will be considered in the nextpaper.

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(5) Finally, Part 6 considers the costs and benefits of reform. These werediscussed in Part 11 of the Consultation Paper. We asked five questions,listed in paragraphs 12.84 to 12.88.

APPROACH 1.12 For each proposal or question, we give a limited amount of context and

background information about the reasons why the Law Commissions made theproposal or asked the question. For a full explanation of our proposals, readersare referred back to the Consultation Paper.

1.13 We then attempt to summarise the written responses we received, indicating thespread of opinion on a particular point. We outline the arguments raised both forand against our proposals. We have provided a few quotations from thoseresponses that were not sent on a confidential basis. We hope these will give aflavour of the arguments raised. However, in a paper of this length, we haveneeded to be selective. Many other points were made that we have not quoted inthe paper, but which will be taken into account in formulating our views.

1.14 Finally, we attempt to give an overview of responses, highlighting any emergingconsensus over the way forward. However, there is not always a consensus. Theproposals on intermediaries remain controversial, with strong arguments on bothsides.

FUTURE WORK 1.15 This paper will be followed by a similar summary of responses to our proposals

for business insurance.

1.16 In the area of pre-contractual information for consumer insurance, we are workingtowards publishing a report and draft bill in Summer 2009. As will be seen fromthis paper, there are still issues that we will need to explore in greater depth. Weintend to consult on these informally as the need arises.

1.17 In relation to the topics to be covered in our second joint consultation paper, wepublished an Issues Paper on Insurable Interest in January 2008. In Autumn2008, we plan to publish further Issues Papers on post-contractual good faith andon whether insurers should be liable in damages for the late payment of claims.

THANKS 1.18 Consultees have produced detailed and well-argued documents that set out

arguments both for and against our proposals. Many people have clearly devotedconsiderable time and resources to this project. We would like to thank all thosewho have sent written responses to our Consultation Paper and met us todiscuss their views.

1.19 We are not inviting comments at this stage. However if, having read this paper,anyone does wish to put additional points to the Commissions, we would bepleased to receive them.

1.20 Please contact us at commercialandcommon@lawcommission.gsi.gov.uk or bypost to Elizabeth Waller, Law Commission, Conquest House, 37-38 John Street,Theobalds Road, London WC1N 2BQ. Tel: 020 7453 1231, Fax: 020 7453 1297.

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PART 2PRE-CONTRACT INFORMATION FROMCONSUMERS

IS THERE A NEED FOR REFORM? 2.1 In the Consultation Paper, the Law Commissions argued that the law on pre-

contract information in consumer insurance is in need of reform. The currentposition has overlapping layers of law, regulation and ombudsman discretion,which we described as needlessly complex, confusing and inaccessible. Althoughthe Financial Ombudsman Service (FOS) provides effective remedies for thecases that come before it, there are serious gaps in the cases the FOS canhandle. We provisionally concluded that there should be a clear statutorystatement of the obligations on consumers to give pre-contract information andthe remedies available to insurers if consumers fail to do so (CP para 12.1).

Support for reform 2.2 The great majority of consultees agreed. This was true not only of consumer

organisations, brokers and lawyers, but also of insurers. Of the 39 insurers andinsurer representatives who responded, only four argued against statutory reformaffecting consumers. Many actively supported reform:

We support the view that the current regime applicable to consumerinsureds would benefit from a clear statutory statement ofobligations… and we support an update to the current law to alignwith best practice. [Royal & SunAlliance Insurance]

The law should be reformed where it currently bears little or noresemblance to market practice. [Zurich Financial Services]

2.3 Insurers argued that a new statute would make the law simpler and clearer forboth policyholders and insurers:

Aviva believes that to codify current best practice would simplify theposition and ensure that it was adopted by all. [Aviva]

We would welcome [reform] so that both the insured and the insurerhave a clear understanding of the position. [Aegon UK]

We believe that making the law fairer and more transparent forconsumers would improve consumer protection by giving consumersthe legal rights they are entitled to. Reform would also enhance thereputation of the industry by reducing the scope for insurers to rely onstrict legal rights that are unfairly balanced in their favour. Reformwould simplify the rules for the benefit of all stakeholders – thesection of the Consultation Paper describing the current law,statements of practice, FSA Rules and FOS approach clearlydemonstrates the confusion and complexity of the current system.Finally, reform should also provide guidance to the FOS on whatParliament considers to be a reasonable balance between theinterests of the consumer and the insurance industry. [Scottish Re]

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2.4 The British Insurance Law Association (BILA) agreed, commenting that “a clearstatement would help consumers know their obligations and the consequences ofbreach and would be a welcome improvement on the current patchwork ofvoluntary statements, regulation and FOS practice”.

2.5 The Chartered Insurance Institute thought that the current lack of legal clarity hada direct impact on the industry’s reputation. They quoted the Financial Mail onSunday which described the practice of trawling back through claimants’ medicalrecords as “the unacceptable side of the insurance industry”. Reform would giveimproved peace of mind that claims would be paid, and provide greater clarity toinsurers’ claims handling, thereby resulting in improved consumer confidence.

The FOS view 2.6 The FOS argued strongly in favour of statutory reform, and against the view that

ombudsman discretion was adequate to ameliorate the harshness of the law.

Our preference is for our decisions to be based on law and for ourdecisions on what is “fair and reasonable” to coincide with the law. Itis much easier to defend and justify our decisions when they areconsistent with the legal position and it is advantageous to all ourpotential users if our decisions can be predicted…. We also take theview that it is logically and morally unjustified to hang on to old law if itis widely agreed that the law is bad and no longer serves any usefulpurpose. [FOS]

2.7 The FOS also pointed out that although it could provide a fair solution to thecases that came before it, not all disputes were within its remit. For example,where disputes exceeded £100,000 it could only make a recommendation.Furthermore, some sectors of the industry continued to follow the law as opposedto the ombudsman approach:

It may be that some insurers who do not have regular dealings withus do not fully understand our approach. It may be however thatsome insurers deliberately apply the legal position and it is only if acomplaint is upheld against them that they are forced to act in linewith our approach. If the law was reformed, this would greatlyincrease the chances that consumers would not need to bring acomplaint in order to be treated fairly. [FOS]

2.8 Some insurers argued that once the law had been changed, the FOS should berequired to make decisions that were in line with the law rather than by referenceto a wider concept of what is fair and reasonable. The FOS responded by statingthat the industry had no reason to fear that it would use law reform as a steppingstone to make further changes in favour of consumers. The reforms by and largereflected its current approach and it had no reason to change this. In handlingconsumer credit, pensions and investment the FOS strove to follow the law andregulations. If the law were updated, it would be able to follow the same approachin insurance. One advantage of law reform would be that it would be much easierto identify where the FOS had departed from what Parliament regarded as “fair”,and to hold the FOS to account, through judicial review if necessary.

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Arguments against reform 2.9 The case against reform was put by the Association of British Insurers (ABI),

arguing that the current system provided flexibility:

The Law Commission should recognise the importance of theprotection currently provided and the value of flexibility in the differentapproaches. A sophisticated system of regulation exists via the FSAand any reform that might take place should not impinge on thissystem thereby creating duplication and uncertainty. There is nowidespread evidence of consumer detriment in relation to the currentlegal position on non-disclosure and misrepresentation, and the needfor reform is therefore not evident. [ABI]

2.10 Fortis Insurance Ltd and ACE European Group supported the ABI’s arguments.

Consumer detriment 2.11 Contrary to the views of the ABI, consumer groups argued that the current legal

position caused consumer detriment. Age Concern cited research they hadconducted with older people about their experience of motor and travelinsurance. It found that many older consumers “were confused about what theyneed to tell their insurer, particularly in relation to health problems”.

The effects can be severe for the individual and also weaken trust inthe insurance industry. [Age Concern]3

2.12 The Multiple Sclerosis (MS) Society thought the current law caused particularproblems for those diagnosed with multiple sclerosis. They sent us 11 extractsfrom anonymised case histories where critical illness claims had been refused,usually because early but undiagnosed symptoms had not been reported.

2.13 The National Consumer Council (NCC) argued that it was unacceptable thatconsumers should have to rely on forbearance by insurers, the rules of theFinancial Services Authority (FSA) or the practices of the FOS:

The law is out of line with good practice and reformed law thatencapsulates good practice should be accessible to consumers.[NCC]

2.14 The Financial Services Consumer Panel described reform as “long overdue”.

Overview of responses 2.15 We are encouraged by the widespread support for reform, particularly from the

insurance industry. The great majority of consultees agreed that there is anurgent need for clear, accessible legislation on consumers’ duties to provide pre-contract information and insurers’ remedies where information is not provided.

3 Age Concern cited several cases reported in their groups where claims had been refusedfor non-disclosure, even though the consumer had not realised the need to disclose.

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DEFINING CONSUMERS 2.16 If there is to be new legislation affecting consumers, the first question is how

consumers should be defined. In the Consultation Paper we provisionallyproposed that the consumer regime should apply to all individuals who enteredinto a contract of insurance wholly or mainly for purposes unrelated to theirbusiness (CP para 12.2).

2.17 Of the 65 respondents who addressed this issue, two fifths simply agreed withoutcomment. However, among those who gave a reasoned response, views weredivided. Three respondents argued that the consumer regime should apply to allpolicyholders, including businesses. Some argued that small businesses inparticular needed more protection, and should be included within the consumerregime if they bought off the shelf products. Others, however, suggested that thedefinition was too wide. Instead they wanted us to follow the narrower approachadopted by the FSA, which is discussed below.

Mixed use policies 2.18 The main issue revolves around mixed use policies. For example, a self-

employed contractor may use a car partly for business and partly for leisure, orhousehold contents insurance may include the contents of a home office. Inthese circumstances, we suggested that the court should look at the mainpurpose of the contract. For example, insurance on a car used mainly as a taxiwith only the occasional private trip would be considered commercial insurance.However, an individual who insured their home contents for £30,000 including£3,000 of business equipment would be considered a consumer.

2.19 However, the FSA takes a different approach to mixed use policies. The newICOBS rules introduced in January 2008 define a consumer as a natural personwho is acting for purposes that are “outside his trade or profession”.4 The FSAclarifies these words by saying:

If a customer is acting in the capacity of both a consumer and acommercial customer in relation to a particular contract of insurance,the customer is a commercial customer.5

This would suggest that an individual insuring a home that includes a home officewould be classified as a commercial customer. Many insurers urged us to followthe FSA approach.

2.20 However, a few people argued that the FSA definition was too narrow, and gaveinsufficient protection to the self-employed. For example, the Financial ServicesConsumer Panel said they fully supported the inclusion of “or mainly” in thedefinition of consumer insurance:

4 Rule 2.1.1(3). We do not think there is a difference between an “individual” and a “naturalperson”. They are both intended to exclude companies and corporations.

5 ICOBS Guidance 2.1.3.

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We agree that consumers, who, for example, insure their home andset aside a room in their house for use as an office, should not findthemselves excluded from the consumer regime. [Financial ServicesConsumer Panel]

2.21 We are keen to eliminate unnecessary differences between our definitions andthose used by the FSA. We therefore held discussions with the FSA to explorethis issue further. The FSA told us that the new ICOBS rules do not draw sharpdistinctions between types of insured. The principles and high-level standards setout apply to all customers. It appears that their definition is not intended to draw asharp or legalistic distinction between people who do (or do not) insure a homeoffice, for example. The problem is that our own legislation will give consumersconsiderably more protection than business customers, and the definition will bemore significant. Therefore, it may well be necessary to take a different approachfrom that of the FSA.

High value goods 2.22 We asked whether there was a need to exempt insurance on specific high value

items (such as jets and yachts) from the consumer regime (CP para 12.3). Amajority of those who addressed the issue thought that, on balance, there was noneed for special exemptions. It would add complexity and cause definitionalproblems. It was also pointed out that a house is often worth more than a yacht:the purpose for which an item is used is more important than its value.

2.23 Only two respondents put forward a reasoned case for an exemption, on thegrounds that those owning high value items often received specialist advice. TheLiverpool Underwriters and Marine Association, for example, argued that theconsumer regime should not apply to items such as valuable art, jewellery orantique collections.

Overview of responses 2.24 The arguments put to us highlighted the difficulties of classifying mixed use

policies. It is increasingly common for people to mix home and work by, forexample, setting up businesses from home. It is important to protect people whoare insuring cars and homes mainly in a private capacity, but who makeoccasional use of these items for business. These people may beunsophisticated buyers, who would not usually be regarded as commercialcustomers.

2.25 Most respondents thought that exemptions for high value goods would be anunnecessary complication.

ABOLISHING CONSUMERS’ DUTY TO VOLUNTEER INFORMATION 2.26 In the Consultation Paper we pointed out that it is now generally accepted good

practice that insurers should ask consumers questions about any material factsthey wish to know. The FOS recognises this, and will refuse to allow an insurer toavoid a policy for non-disclosure where no question is asked. We thought thatthis should be codified in law. We provisionally proposed that there should be noduty on a consumer proposer to disclose matters about which no questions wereasked (CP para 12.4).

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2.27 Most respondents, including most insurers, agreed on the grounds that thisreflects the FOS’s existing approach and long established good practice. AsAegon UK put it:

In reality we come across very few situations where the residual dutyof disclosure kicks in. There is, we believe, some confusion in theindustry as to the difference between the residual duty of non-disclosure and misrepresentation. The term “non-disclosure” isroutinely used when referring to something that amounts to amisrepresentation. [Aegon UK]

2.28 The argument made against abolishing the duty was that it would lead to longand complex application forms. The Institute of Insurance Brokers said:

We do not believe that it is practically possible for an insurer to askevery possible material question relating to a risk at the time ofproposal. An attempt to do so would create proposal forms ofenormous size and complexity – which would add substantial costs tothe business process. [IIB]

2.29 They thought that private policyholders should be under a duty to discloseanything that a right-minded lay person would consider material, whetherspecifically asked for or not. Hill Dickinson LLP gave an example where keys hadbeen taken in a previous break-in and the locks had not been changed.

2.30 That said, most insurers accepted the FOS approach. In practice, they alreadyoperate on the principle that policyholders are only required to answer thequestions asked – and they still respond to market pressures to keep forms short.Lloyd’s said that whilst they would prefer in principle to retain a duty of disclosure,they recognised that “the practice of the FOS may have taken expectations pastthe point of no return”.

2.31 A few respondents asked how abolishing the duty to disclose would operate inspecific fact circumstances, such as renewals and cases of commission fraud.Our proposals meant that, for renewals, insurers would at least have to ask ageneral question about whether anything had changed. The effect of such aquestion is explored below.

The effect of general questions 2.32 In the Consultation Paper we proposed that insurers should be allowed to ask

general questions, but should take the risk they may receive vague answers. Forexample, if a proposal form asked about “any ailment or disease from which yousuffer or have suffered”, a reasonable policyholder would understand that theyshould mention the recent diagnosis of cancer. However, they may not realisethat they should mention an operation for an ingrowing toe-nail five years ago.We thought that insurers should be entitled to a remedy for the first omission, butnot for the second. We provisionally proposed that the insurer should have noremedy in respect of an incomplete answer unless a reasonable consumer wouldunderstand that the question was asking about the particular information in issue(CP para 12.5).

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2.33 Most respondents agreed with us. The FOS commented that “this reflects ourexisting approach, which itself reflects long-established good industry practice”.

2.34 Fifteen respondents disagreed with the proposal. Several industryrepresentatives were concerned that the test was uncertain, and that judges maydisagree about what was reasonable for a consumer to do. The Investment & LifeAssurance Group (ILAG) asked for more clarity about what constitutes areasonable consumer.

Any assessment is bound to involve a degree of subjectivity and itwould be useful for the industry to work to commonly recognisedbenchmarks based on the normal characteristics of consumers.[ILAG]

2.35 The ABI suggested that the statute should be less specific. Instead they arguedthat the matter should be left “to the FSA Conduct of Business Rules andapplication of the Treating Customers Fairly (TCF) principle”.

2.36 By contrast, some academics and consumer groups thought that generalquestions could operate as a trap and should not be allowed at all. Age Concerncommented that for some consumers, “answering a general question may involvequite a lot of worry and inconvenience” while others are “less careful”. Theyasked for more exploration of alternative approaches.

2.37 In some cases, respondents were unclear about the test we were proposing. THMarch & Co, the brokers, gave an example: if a question in a buildings policyproposal asked “are there any other hazards we should know about?” would areasonable consumer mention that they manufactured fireworks at home? Wethink the answer would be: “yes”. Although the question was general, thisparticular hazard was so obvious and extreme that it is the sort of thing that oughtto be mentioned by a reasonable consumer. However, it may not be reasonableto expect the consumer to mention that they are near a river in response to sucha question: if insurers want information to assess flood risk, they should ask for it.

Overview of responses 2.38 Most insurers agree that consumers should not be expected to volunteer

information for which they have not been asked, and that this representsaccepted practice. Furthermore, most respondents agreed with our proposals ongeneral questions, which represent the current FOS approach.

THE BASIC REQUIREMENTS: MISREPRESENTATION AND INDUCEMENT 2.39 Under current law, to establish liability for misrepresentation, the insurer must

show that the consumer has made a misrepresentation that induced the insurerto enter the contract. We provisionally proposed to retain these elements of thecurrent law (CP para 12.6). We also asked whether we should define whatconstitutes a misrepresentation and inducement in the new Act (CP para 12.7).

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2.40 Given that this question merely replicates the current law, we did not expect theissue to be controversial. This proved to be the case. Respondents mostlyagreed that we should retain the current law. The majority thought that we shoulddefine misrepresentation and inducement, especially if we could do so in a waythat was “clear, unambiguous and free from jargon”. However, a substantialminority thought that the matter could be left to the common law. Lord Justice Rixsuggested that the rules should be stated only “in barest outline”. We should“beware instant ossification”.

2.41 The only issue to generate debate was on how far it may be possible to make amisrepresentation by omission – that is, by failing to answer a question fully. Inthe Consultation Paper, we explained that an answer may be literally accuratebut may still amount to a misrepresentation because it is incomplete. We gave anexample where the proposer was asked whether they had ever suffered from alist of illnesses, and mentioned some illnesses but not others. We explained thatthis may well amount to a misrepresentation.

2.42 Several respondents referred us to the case of Winter v Irish Life Assurance plc,6

which illustrates this principle. The applicant filled in a form. Question 2 asked“are you at present suffering from any physical defect or illness?”, the answer towhich was left blank. Question 3 asked “have you had any medical or surgicalattention? If yes please give full details. The applicant answered “yes” and wrote“MECONIUM ILEUS (3 days old)”. She did not mention that she had cysticfibrosis or that she had undergone a liver biopsy. The judge found that the twoanswers taken together could fairly be taken to mean that she wasmisrepresenting the facts by claiming that she was suffering from no physicaldefect or illness, and had had no significant medical attention since she wasthree days old.

2.43 Our intention was to preserve the approach taken in Winter: it would remainpossible to mislead by failing to add information to the form. However, if theapplicant clearly fails to answer questions, in a way that is not misleading, thenthe onus would be on the insurer to follow up the issue.

Overview of responses 2.44 The requirements for misrepresentation and inducement are already part of the

law, and there was general support for preserving them.

DELIBERATE OR RECKLESS MISREPRESENTATIONS 2.45 In the Consultation Paper, we proposed that where a consumer has made a

deliberate or reckless misrepresentation, the insurer should be entitled to avoidthe contract and refuse all claims that arise under it. We thought this wasappropriate even if the effect of avoiding the policy over-compensates insurers forthe loss they have suffered – where, for example, the insurer would still haveaccepted the risk for only a slight increase in premium had it known the truth. Thereason was that where the policyholder is morally blameworthy, it is right to showsociety’s disapproval of the behaviour and discourage wrongdoing. Almost allrespondents agreed with us.

6 [1995] 2 Lloyd’s Rep 274.

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The definition of “deliberate or reckless” misrepresentations 2.46 The difficult issue is how “deliberate or reckless” should be defined. In the

Consultation Paper we proposed that the insurer would need to show, on thebalance of probability, that the proposer made the representation:

(1) knowing it to be untrue, or reckless as to whether or not it was true; and

(2) knowing it to be relevant to the insurer, or being reckless as to whether ornot it was relevant (CP para 12.8).

2.47 The FOS commented that “this reflects our existing approach”. However, someinsurers thought that it went further than the current position, and would be toodifficult to meet:

We question whether insurers will be able to take advantage of theconcept because of the evidential burden. [Brit Insurance]

2.48 Around 10 insurers expressed concerns about the second limb of the test. As theBritish Insurance Law Association (BILA) put it:

We have some concern that this two-part test would effectively allowthe insured to provide information it knows is false… provided it didnot think it was relevant to the insurer. [BILA]

2.49 The ABI thought that “it would be impossible to prove or disprove” what aproposer thought was relevant. The Lloyd’s Market Association felt that thispaved the way for dishonest behaviour.

2.50 On the other hand, the MS Society thought that more ought to be done to protectthose who omitted medical details that they thought were trivial at the time, onlyto find in retrospect that the insurer regarded them as relevant early symptoms ofmultiple sclerosis. They gave examples of members being refused payouts onthe basis of undeclared pins and needles or very brief episodes of numbness thatseemed irrelevant at the time. The MS Society was concerned about anydefinition based on “recklessness”: they thought that avoidance was onlyappropriate where information was “knowingly withheld”.

2.51 We were interested to note that this issue was recently considered by the PrivyCouncil in Zeller v British Caymanian Insurance Co Ltd.7 Lord Bingham ofCornhill, giving the opinion of the court, commented that where an applicant isasked whether he had recently consulted a doctor

he is expected to exercise his judgment on what appears to him to beworth disclosing. He does not lose his cover if he fails to disclose acomplaint which he thought to be trivial but which turns out later to bea symptom of some much more serious underlying condition.8

7 [2008] UKPC 4. The case is decided under Cayman Law, which follows the common lawapproach.

8 [2008] UKPC 4, para 20.

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It would therefore appear that knowledge of relevance is already a factor thecourts take into account in assessing the answers consumers give to questions.

Presumptions of knowledge 2.52 There is clearly a difficult balance here. On the one hand, it should not be made

overly difficult for insurers to prove that a proposer acted deliberately orrecklessly when they must have known that they were not giving the correctinformation. On the other hand, many questions are extremely general. Where aform asks people if they have visited a doctor in the last five years, they routinelyinterpret the question to refer only to relevant issues. Consumers may omit a visitabout a viral infection without having any notion that they are acting dishonestly,or that it may turn out to be a relevant early symptom.

2.53 In order to achieve this balance, we asked whether the statute should expresslystate that:

(1) a proposer would be presumed to know what someone in their positionwould normally be expected to know; and

(2) if the insurer asked a clear question about an issue, the proposer wouldbe presumed to know that the issue is relevant to the insurer. (CP para12.11)

2.54 We explained that this would not help insurers if they asked vague, general orambiguous questions. But where a question was clear, the onus would be on thepolicyholder to show why they did not think the issue was relevant.

2.55 Most respondents welcomed these presumptions. The ABI described them as“vital presumptions needed to assist insurers”. However, they thought that wherea question was specific, there was no need to consider whether the consumerknew its relevance: the fact that the insurer had asked the question demonstratedits relevance.

2.56 A few respondents commented on the wording of these presumptions, takentogether with the primary test. For example, it was suggested that presumption(2) should only apply to questions that were clear and specific. As the FinancialServices Consumer Panel put it, “a clear question can still be a general question”.Lloyds thought that insurers should not have to show that the consumer knew orwas reckless as to whether a matter was relevant. Instead it would be enough ifthey knew (or were reckless) as to whether it might be relevant.

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“Recklessness” 2.57 Recklessness is a difficult concept to pin down. In the case law it is described as

making a statement without caring whether it is true or false.9 It is said to requirea lack of interest in whether a statement is true – not just a lack of reasonablegrounds for believing it is true (which is merely negligent). In the ConsultationPaper we explored ways in which we could explain the concept more precisely,but concluded that the issue was best left to the common law (CP para 12.9).

2.58 Of the 60 consultees who addressed this issue, four fifths agreed with us. TheABI thought that the common law definition should be retained, but suggestedthat further guidance could be given by regulatory bodies or the ABI. Munich ReUK Life Branch suggested that the Law Commissions might engage with the ABIand the FOS over such guidance.

2.59 Those who argued for a definition thought that there was a need to clarify theconcept for policyholders and/or insurers. The FOS commented that:

Our workload suggests that there is a very poor understanding of thedefinition of “reckless” in law amongst insurance practitioners. Itwould be worthwhile attempting a statutory definition to put the matterbeyond doubt and to introduce some consistency amongst thoseseeking to respond to any new legislation. [FOS]

Overview of responses 2.60 There seems to be general agreement about the concept of “deliberate or

reckless misrepresentation”, but some continuing concern over the details of thedefinition. Respondents generally agreed with the Derry v Peek approach torecklessness (which distinguishes between “not caring” whether a statement istrue and acting “carelessly”). They also supported enshrining the presumptions inlegislation. The most controversial issue is whether someone is dishonest if theydo not mention something because they do not think it is relevant, though arecent Privy Council case suggests that the courts already take into account theconsumer’s knowledge of relevance in assessing misrepresentations.

Retaining premiums 2.61 At present, when an insurance policy is avoided the insurer will normally return

the premium. The FOS states that, where a consumer acts “fraudulently”, theinsurer may keep the premium, but the burden of proving “fraud” is extremelyhigh. In our survey, we did not find any cases where premiums had been kept inthis way.

2.62 In the Consultation Paper we argued that where a consumer had acteddeliberately or recklessly, it was important to send a strong social message thatsuch behaviour was unacceptable. We therefore asked whether in cases ofdeliberate or reckless misrepresentation, the insurer should be entitled to retainthe premium (CP para 12.10).

9 Derry v Peek (1889) LR 14 App Cas 337.

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2.63 Out of 64 consultees who responded to this question, the vast majority (85%)agreed. It was felt to be appropriate to show society’s disapproval, to deterwrongdoing and to compensate the insurer for the administrative costs they hadincurred.

2.64 The minority who argued against this proposal thought that it would be overlyharsh on the policyholder and would give the insurer an unjustified windfall. TheFOS commented that the remedy of avoidance was harsh enough. They wereconcerned that “insurers might wrongfully retain premiums without being able toadequately prove that the insured acted dishonestly or fraudulently”. JonathanHirst QC and the Financial Services Consumer Panel argued that there should bediscretion for the courts or the FOS to order repayment in appropriatecircumstances.

2.65 Two brokers suggested the money might instead be paid to a central fund:

[Retaining the premium] would constitute a windfall for the insurer… Ifthe insurer is able to avoid the policy and it is deemed necessary for asanction to be applied to the insured, the premium could be forfeitedto a central fund. [Marsh and Guy Carpenter Ltd]

It was suggested that the fund might be used, for example, to offset the runningof the FOS or to support insureds affected by failure of an insurer.

2.66 It was also pointed out that we failed to explain how the principle would apply toinvestment policies:

The premium for a With Profits endowment policy has an element oflife cover, it also has an element of the investment. Is it equitable thatthe insurer will profit by the retention of any investment gain? [MrMark Wibberley, Broker]

2.67 Thus there was general support for retaining premiums, but some notes ofcaution that it should not operate unduly harshly, by (for example) depriving adeceased’s estate of the investment element of a life policy.

The ABI Guidance on long-term protection policies 2.68 Since we published our Consultation Paper, the ABI has provided further

guidance about how the long-term protection industry should handle claims. Thissets out circumstances in which the life and critical illness insurer should notavoid the policy, even though the applicant has acted deliberately or without anycare in giving incorrect information. In particular, the Guidance states that theinsurer should not avoid where:

(1) the degree of materiality associated with the non-disclosure is relativelylow (for example where it would have increased some part of thepremium by no more than +50%);10

10 Para 8.3.2.

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(2) the information relates only to a “severable benefit” such as a TotalPermanent Disability benefit, where the claim is for a critical illness;11

(3) the insurer only knows about the incorrect statement because it hasconducted an unjustified trawl through medical information.12

2.69 In the Consultation Paper we said it was important to give a clear andunambiguous message that this behaviour is wrong, even if the insurer wouldhave accepted the risk for only a slight increase in premium. Otherwise the lawrisked giving policyholders the impression that they could get away with lying.

2.70 However, the industry has agreed to a softer approach. This raises questionsabout what status such Guidance might have under a new statutory regime,where insurers voluntarily agree to treat dishonest consumers more leniently thanthe law requires.

2.71 Professor Robert Merkin of Southampton University drew attention to theAustralian legislaton. This gives the courts a discretion to prevent avoidance inthe case of fraud where it would be harsh and unfair and a lesser remedy ofdamages would be just and equitable.13 He thought this worked well and thesame discretion should be available in the UK.14

“INNOCENT” MISREPRESENTATIONS

Protecting consumers who acted honestly and reasonably 2.72 In the Consultation Paper we argued that a consumer’s duty is to be honest and

careful in answering the insurer’s questions. We provisionally proposed that aninsurer should not be able to rely on a misrepresentation if the insured was actinghonestly and reasonably in the circumstances when they made themisrepresentation (CP para 12.12(1)).

2.73 The responses suggested that this is already a well-established principle withincurrent insurance practice. Out of the 62 consultees who addressed this issue,82% agreed with our proposal, usually without comment. The ABI said:

We have no objection to this formulation in relation to the honestconsumer proposer. It is in line with current FOS decisions, industrypractice and FSA regulation. [ABI]

11 Para 6.2.12 Para 3.7 states that insurers should not ask for information beyond that needed to assess

the claim or to manage a disability claim, unless they have reasonable grounds for thinkingthere may be a non-disclosure. It does not say what should happen if the insurer obtainsinformation improperly and then discovers a deliberate misrepresentation. However, wehave been told that the Guidance implies that insurers will not use the information againstthe policyholder.

13 Insurance Contracts Act 1984, s 31.14 He argued that a discretion would be particularly important if the agent’s intention were to

be imputed to the policyholder, so that the insured would be denied all claims becausetheir intermediary had been fraudulent. He did not think that the policyholder’s right to suethe broker would be adequate in such circumstances.

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However, the ABI thought that legislation was not required.

2.74 The Lloyd’s Market Association was the only respondent to argue strongly thatinsurers should retain the right to avoid policies for innocent mistakes. Lloyd’sthemselves thought that avoidance was right in principle, but could see reasonsto bring the law into line with current market practice:

Our preference would have been to retain the right of avoidancebecause we do not think that there is a sufficient case for the risktransfer of the facts not being as stated or perceived where theinsurer would have regarded them as material. However, werecognise the undesirability of the substantive law being out of kilterwith ICOBS 8.1.2 and FOS practice on this point. A proportionateremedy, such as that proposed in cases of negligentmisrepresentation might have been more appropriate. Ultimately theadditional risk transfer may be reflected in the pricing. [Lloyd’s]

2.75 A few respondents pointed out that the proposed approach differed from theremedy available for an innocent misrepresentation in general contract law. InEngland and Wales, the court has a discretion under the Misrepresentation Act1967 to award damages in lieu of rescission.15 The appropriate measure ofdamages is uncertain: we did not find any cases in which the section had beenraised in a consumer insurance case, or indeed where a consumer had beenordered to pay damages to any non-insurance business for an innocentmisrepresentation. It is likely however that the measure of damages would below,16 probably no more than the difference between the premium paid and thepremium that should have been paid. There was little enthusiasm for a damagesremedy of this type.

The “reasonableness” test 2.76 In the Consultation Paper we discussed what circumstances the judge or

ombudsman should take into account in assessing whether the consumer actedreasonably in all the circumstances. We considered whether the test should besubjective, and take into account the consumer’s individual circumstances, orwhether it should be objective, looking at what one would expect from areasonable consumer in the market. In particular, should the judge orombudsman take into account the consumer’s age, education and knowledge ofEnglish?

2.77 We provisionally proposed that the basic test should be objective, looking only atthose issues that apply to normal consumers in the market, including the type ofpolicy and the way the policy was advertised and sold. It would only take accountof issues such as the consumer’s age or knowledge of English in so far as thesewere known to the insurer (CP para 12.12 (2) & (3)).

15 s 2(2). For a discussion of this remedy and the relevant Scots law, see our Issues Paper 1,Misrepresentation and Non Disclosure (2006), Appendix A.

16 See William Sindall v Cambridge County Council [1994] 1 WLR 1016.

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2.78 The FOS pointed out that this was a harsher test than the one they currentlyemploy. They feared that our proposals did not provide sufficient protection forthose without financial capability (described as “honest but dim”). At present, theFOS will often apply a subjective standard, and take into account consumers’lack of capability.

2.79 Age Concern strongly supported the proposal that insurers should not be able toavoid for innocent misrepresentations. However, they thought that the proposedtest was too harsh:

This definition will greatly prejudice vulnerable consumers, such asthe example cited in the paper of a widow who has never had to dealwith home maintenance and who is unaware that the cracks are asymptom of subsidence. [Age Concern].

2.80 Perhaps unsurprisingly, most industry representatives supported our proposal fora more restricted test of reasonableness, usually without discussion. However,many respondents were uncertain about how our test differed from currentpractice. One insurer sensed that our intention was “to reduce the standards thatapply to insureds”. In fact, our intention had been the opposite: to tighten thecurrent subjective test in favour of insurers. However, this was not alwaysunderstood.

2.81 Many industry respondents opposed the idea that the test should take intoaccount consumers’ subjective circumstances where these were known to theinsurer. The ABI viewed the proposal as placing an obligation on sales staff toassess whether or not the proposer fully understands the nature of the contract.They thought that insurers may refuse to deal with some applicants for fear thatthey may later argue that they were not in a position to contract. Scottish Widowsand Scottish Re also thought that the proposal may lead to social exclusion, asinsurers would become more wary of dealing with some classes of consumers:

This proposal places an obligation on sales advisers to assesswhether or not the applicant fully understands the nature of thecontract. A line is then expected to be drawn between advisersacknowledging a genuine application for insurance from someonerecently bereaved or who is not fluent in English and refusing to dealwith the applicant for fear that the applicant may later argue that theywere not in a position to contract. This line may be difficult to draw. Inthe event of a recently bereaved applicant, being refused to be dealtwith is likely to exacerbate an already difficult time leading tocomplaints against the adviser. [Scottish Widows]

2.82 It was also suggested that consumers might use their poor knowledge of Englishas an excuse:

If somebody genuinely does not have a sufficient knowledge andunderstanding of English they should utilise the services of a friend,family member or broker to help them arrange an insurance contract.Aviva has seen a few cases in the past where the client suggests thatthey do not “understand” at the time of the claim. The inception calldoes not however support that statement. [Aviva]

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2.83 The insurers who made these comments did not appear to appreciate that theFOS will already take subjective factors into account, and may (for example)require less understanding from someone with limited literacy than they wouldfrom a graduate. The proposal would protect insurers where they are unaware ofsubjective factors, and keep it much as it is where insurers are aware of theproblem.

2.84 A few respondents made more specific comments on the test. Friends Provident,for example, commented that when looking at the way the insurance was sold, itwas important to distinguish the actions of the insurer from those of theintermediary. They therefore suggested that, instead of looking “at the way thepolicy was advertised and sold” the test should look at “any policy literature andother advertisements issued by the provider”.

The issue of relevance 2.85 In the Consultation Paper we commented that a consumer may make an honest

and reasonable misstatement for several reasons. They may, for example, havean honest and reasonable belief that what they said was true. Alternatively, theymay genuinely and reasonably have thought that any inaccuracy or omission wasnot relevant to the insurer, often because a question was worded in a confusing,general or ambiguous way. Our survey of ombudsman cases suggested thatmany cases turned on what a reasonable person would understand by thequestion. For example, what would a reasonable person think an insurer wantedto know about when it asked for a list of “uninsured losses” in the context of ahousehold contents policy?

2.86 We asked if the legislation should specify that the insurer is entitled to a remedyfor a misrepresentation only if:

(1) a reasonable insured in the circumstances would have appreciated thatthe fact would be one that the insurer wanted to know about; or

(2) the proposer actually knew that the fact was one that the insurer wouldwant to know about (CP para 12.13).

2.87 Most respondents who addressed this question agreed with our proposal, oftenwithout comment. However, a minority argued that the test was unnecessary andpotentially confusing. The ABI, for example, was unclear what further assistancethe test provided.

2.88 It is true that this proposal does not add anything of substance to the general testof reasonableness (in CP para 12.12) or to the general test of honesty (in CPpara 12.8). The proposal is only intended to make explicit a point that is alreadyimplicit in those tests. If respondents do not find it a helpful clarification, theprovision could be omitted from legislation.

The burden of proof 2.89 In the Consultation Paper we proposed that the burden of showing that a

consumer proposer who made a misrepresentation did so unreasonably shouldbe on the insurer (CP para 12.14).

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2.90 This drew a mixed response. Over half of the sixty respondents who answeredthis question agreed with us. BILA, for example, gave their qualified approval,stating:

Provided… that the standard of reasonableness is always that of thereasonable insured in the circumstances, the presumptions as to theinsured’s knowledge are as in Q12.11 and the standard of proof is thebalance of probabilities, we consider the test sufficiently objective forinsurers to take on this burden. [BILA]

2.91 However, many insurers disagreed. They argued that it would be extremelyonerous for the insurer, as the consumer knows more about the circumstancesthan the insurer. As the ABI put it, “the consumer is in a far better position toprovide evidence about what they did or did not know”.

2.92 The provisional proposal was based on the assumption that, in most cases, verylittle evidence would be needed. The insurer would prove that the applicant hadmade a misrepresentation, providing a copy of the form. It will usually besufficient for judges or ombudsmen to put themselves in the position of areasonable consumer and ask what they would have done in the circumstances,bearing in mind the questions asked.

Materiality: an end to the test based on a hypothetical “prudent insurer”? 2.93 Under our provisional proposals, insurers would need to show that the

misrepresentation induced them to enter into a contract, and that a reasonableinsured would realise that the issue was relevant to them. We proposed that,once an insurer had done this, it should not also have to show that the issuewould be relevant to a hypothetical prudent insurer, as is currently required undersection 20 of the Marine Insurance Act 1906. We thought that an additional“prudent insurer” test might place a burden on niche insurers, whose underwritingcriteria differed from others in the market.

2.94 We therefore proposed that insurers should not be required to prove that amisrepresentation is “material”, in the sense that it would be relevant to a“prudent insurer” (CP para 12.15).

2.95 This was supported by the great majority of those responding. As Aegon UK putit:

We agree with this as it is open to insurers to insure on whateverbasis they decide and what is material to one insurer may not bematerial to another. Whether or not that is prudent in the eyes ofanother insurer is of no relevance to the risk that the insurer inquestion wishes to take on. [Aegon UK]

2.96 No-one wanted to see a “prudent insurer” test of materiality operate in addition toa reasonable insured test. The only objections to this proposal came from thosewho opposed a reasonable insured test. The Lloyd’s Market Association wishedto preserve a test of materiality based on a reasonable insurer rather than areasonable insured.

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Where the policyholder thinks the insurer will obtain the information 2.97 A common reason why consumers do not fill in forms completely is because they

think the insurer already has access to the information and will check theinformation for itself. In one survey, the main reason consumers gave for failing toprovide all the relevant information on their medical history was that theyassumed the insurer would ask their doctor.17 Similar problems may occur wherethe insured knows that the insurer holds detailed information about previousclaims or is in a much better position to check the area’s flood history.

2.98 In our first issues paper, we considered whether there should be specificobligations on insurers to check their own records, or to obtain medical reportswhere they have gained consent for them. However, in the Consultation Paperwe argued that this was too prescriptive, and may cause practical difficulties.Instead, we thought that the issue was best addressed as part of thereasonableness test.

2.99 We provisionally proposed that in considering whether an insured acted withinsufficient care in failing to give information, the judge or ombudsman shouldconsider how far it was reasonable for the insured to assume that the insurerwould obtain that information for itself (CP para 12.16).

2.100 In particular, we were concerned about cases where the insurer suggested that itwould obtain information from a third party (by for example asking the insured forconsent to obtain a medical report). We thought that an insurer should not beallowed to rely on an honest misrepresentation if the insured reasonably thoughtthat the insurer would obtain the relevant information from the third party (CPpara 12.17).

2.101 Over half of the respondents agreed with us. In the Consultation Paper wesuggested that, in practice, many of the problems could be solved by includingclear warnings on forms (such as those recommended by the ABI). This, inparticular, drew support. For example, RGA Reinsurance UK Ltd (RGA) endorsedthe ABI guidelines on this issue. They thought that insurers:

should warn proposers that they may not necessarily obtain adoctor’s report and that providing an accurate disclosure remainstheir responsibility. [RGA]

2.102 The National Consumer Council disagreed with our proposals, arguing thatinsurers should be under an obligation to check information:

17 Swiss Re Life and Health, The Insurance Report (2005) p 28.

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As the Consultation Paper acknowledges, the NCC made the pointabout insurers’ access to databases etc in its 1997 Report. Weremain of the view that in this technological age, insurers ought to beable easily to check a proposal form against information to which theyhave access, including in their own files and on Claims andUnderwriting Exchange and publicly available information relating toflood risks. We firmly believe that they should be deemed to have thisknowledge, notwithstanding alleged difficulties regarding incompatiblesystems etc. We are also very strongly of the view that they should bedeemed to know what is in their own paper-based files. [NCC]

2.103 However, many insurers expressed considerable concern about any idea thatinsurers should be required to check files. It was thought to encouragedishonesty. The Investment & Life Assurance Group (ILAG) said it might create“an unfortunate loophole for the proposer to exploit”. Some insurers suggestedthat although we were not proceeding with the idea that insurers should bedeemed to know information on their files, our proposals would still allowconsumers to raise this as an argument. As NFU Mutual put it:

It will allow insureds to manipulate the system. For example, aninsured might disclose a speeding conviction in the course of buyinghis house insurance but conceal the same conviction whenpurchasing motor insurance from the same insurer. On the currentproposal, the insured would be able to raise a defence that theinsurer ought to have checked its own records to discover thespeeding conviction itself. Whilst insurers would probably still prevailin these circumstances…, the existence of a potential defence seemsincongruous and unnecessary. [NFU Mutual]

2.104 The ABI commented that if insurers are to rely on questions they ask, they mustbe able to expect full and complete answers.

There should be no scope for an insured to presume that an insureralready has information that they are specifically asking about in aproposal form. [ABI]

2.105 We agree that insurers are entitled to expect consumers to answer questionshonestly and fully to the best of their knowledge and belief. Our proposals did notcover the situation where a consumer has deliberately or recklessly failed to giveinformation. They deal with the more difficult issue of what standard of“reasonable care” a consumer must meet in obtaining and checking information.The proposals are designed to impose an objective test. The consumer must actreasonably in answering the question, but is not expected to go to “unreasonable”lengths in checking their own records, contacting their doctor, or searchingexternal databases.

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2.106 As we said in the Consultation Paper, it seems harsh to reject a claim because aconsumer has not taken the trouble to find out the true facts, when the same canequally be said of the insurer. If the insurer expects a consumer to check papersrelating to their claims or medical records in circumstances when the insurer isnot prepared to carry out the checks itself, we thought that it must draw thisobligation to the consumer’s attention very clearly. Lloyd’s suggested that thiswas particularly important on renewal when it came to giving information aboutprevious claims with that insurer.

In most cases the renewing insured will assume that his claims recordis accessible to the insurer from the insurer’s own records, and will beautomatically available to the insurer in considering therenewal/premium etc. If this is not a valid assumption the insurershould be required to say so expressly. [Lloyd’s]

Overview of responses 2.107 There is widespread support for the view that applicants who act honestly and

reasonably should be protected. As the ABI point out, this is already in line withindustry practice.

2.108 The challenge is to draft a test for what amounts to a “reasonablemisrepresentation” that is at the right level of principle. The Act needs to givesufficient guidance about how the test applies, without being overly prescriptive ina changing market.

A CONTINUING DUTY OF DISCLOSURE? 2.109 In the Consultation Paper, we considered what should happen where a consumer

made an innocent mistake on an application form and then discovered it waswrong. Should they have a duty to inform the insurer?

2.110 Under current law, if a party has stated a material fact that was true at the time,but ceases to be true before the contract has been made, they must correct thestatement. A similar principle would apply if someone says something in goodfaith, and then discovers they are wrong.

2.111 However, once the contract has been made, the duty to disclose ends. There isno general or statutory obligation on the policyholder to inform the insurer of achange of circumstances. If an insurer wants to be notified about changingcircumstances, they must add an express term to the policy. Such a term wouldbe subject to review under the Unfair Terms in Consumer Contracts Regulations1999.

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2.112 It is common for critical illness cover to start several months after the policy hasbeen agreed. Where this happens, insurers often include express terms requiringconsumers to notify the insurer of any changes in their health betweencompleting the application and the date that cover starts. These terms generatesome dispute.18 Where an insurer rejects a claim on the basis of a failure to notifyafter the contract has been formed but before cover starts, the FOS will look atthe decision critically. Ombudsmen are prepared to overturn a decision if theapplicant had not been given a clear warning.

2.113 Essentially we proposed to retain the current law. We provisionally proposed that:

(1) Where, before a proposal is accepted, a consumer proposer becomesaware that a statement they have made has become incorrect, theyshould continue to have a duty to inform the insurer. If they failed to doso unreasonably or dishonestly, the insurer should have a remedy. Theinsurer would not need to include an express term to this effect.

(2) There should be no general obligation to inform the insurer of thechanges that became known to the insured only after the policy has beenagreed. If insurers wished to receive such information, they would needto add an express term to that effect to the policy (CP para 12.18).

Before acceptance 2.114 The great majority of respondents agreed that consumers should have a duty to

correct mistakes up until acceptance. A few respondents commented, however,that the insurer must bring this duty to the consumer’s attention:

We agree but only if the insurer brings the continuing duty ofdisclosure to the attention of the proposer and provides a list of theproposer’s statements in order for the proposer to know whether anystatements have changed. [FOS]

We are strongly of the view that the duty should only apply if therewas a clear warning about it given to the proposer. [NCC]

2.115 Under our proposal, the insurer would only have a remedy insofar as the failurewas dishonest or unreasonable. The issue of warnings would be an importantfactor in assessing reasonableness.

After acceptance 2.116 The issue of a continuing duty to inform after acceptance drew more comments.

Many lawyers and insurers asked whether they would continue to be entitled toadd express terms to notify within their contract. We were asked to explain whensuch terms would be permitted and what their status would be. As the ABI put it:

18 In our survey of 190 final ombudsman decisions on non-disclosure, this issue arose in 27critical illness cases. See Consultation Paper, p 364.

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In the case of annual travel insurance, a policyholder is often requiredto disclose new illnesses/conditions before taking a trip but after thepolicy has been issued. It is not clear how such an instance would bedealt with under these proposals. [ABI]

2.117 Many life and protection insurers stressed the need for disclosure afteragreement but before inception of the policy. As Scor Global Life put it:

In the absence of such a disclosure regime, life insurers are exposedto a risk of anti-selection, particularly when there is a significant timelag between acceptance of the risk and the date the policy actuallygoes on risk – such delays typically occur when policyholders applyfor cover in connection with a mortgage. Life insurers will typically askthe customer to sign a further Declaration of Health after three to sixmonths in these cases. [Scor Global Life]

2.118 We think these comments are based on a misunderstanding. Under the currentlaw, insurers may include an express term in the contract requiring suchdisclosure. This would continue. Our proposals do not involve changing the law inthis regard.

NEGLIGENT MISREPRESENTATIONS: A COMPENSATORY REMEDY 2.119 Many misrepresentations are made honestly but negligently. This covers a broad

swathe of conduct, where the policyholder failed to take sufficient care tounderstand what the insurer wanted to know or to check their facts. In theConsultation Paper, we said that we did not need a separate definition ofnegligence. A misrepresentation is negligent if it is not deliberate or reckless (asdiscussed above), but was not made with reasonable care.

2.120 For negligent misrepresentations, we thought that the insurer should have aremedy - but the right to avoid the whole policy went further than was necessaryto protect the insurer. Avoidance, for example, allows an insurer to refuse a claimfor cancer because they were not told about hearing loss - even if, had theyknown about the hearing loss, they would only have excluded hearing claimsfrom the policy.

2.121 We said that the law should aim to place the insurer in the same position as itwould have been in had it known the true facts. This would involve looking atwhat this particular insurer would have done. For example:

(1) Where the insurer would have excluded a particular type of claim, theinsurer should not be obliged to pay claims that would fall within theexclusion;

(2) Where an insurer would have imposed a warranty or excess, the claimshould be treated as if the policy included the warranty or excess;

(3) Where an insurer would have declined the risk altogether, the policy maybe avoided, the premiums returned and the claim refused;

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(4) Where an insurer would have charged more, the claim should be reducedproportionately to the under-payment of premium. For example, if aninsurer would have charged £2,000, but only charged £1,000, theconsumer would receive half their claim (CP para 12.19).

Arguments in favour 2.122 Around three-quarters (74%) of those who addressed this issue agreed. The

FOS, for example, thought it was a fair and workable solution:

In our experience, over a number of years, the insurance sector hasno problems with applying this remedy (ie re-underwriting policies onaltered terms and/or making partial claim settlements) when it hasbeen decided by us. We therefore see no reason why proportionalitycould not be enacted into law. It is also our experience thatconsumers also recognise this approach as fairer than outrightavoidance in cases of non-dishonest misrepresentation. [FOS]

2.123 The Chartered Insurance Institute agreed and welcomed the change in principle:

As a professional body with a remit to protect the public by guidingthe profession, we concur with the Commissions’ approach regardingthis core area of the consultation. We cite the many controversialcases where insurers have denied claims or avoided policies arisingfrom innocent or unintentional misrepresentations, so the logic aroundthe proportionality test and compensatory remedies to align moreclosely the compensation charged on the consumer with the harmsuffered by the insurer is welcomed. [Chartered Insurance Institute]

2.124 Lloyd’s reluctantly accepted it as current FOS practice:

We agree, not in principle, but rather on the basis that this proposalwill bring the substantive law as regards consumers into line withestablished FOS practice and it is undesirable to have concurrentconflicting systems. [Lloyd’s]

Possible problems 2.125 Many respondents raised possible practical problems. As the Jardine Lloyd

Thompson Group put it, the remedy is “easy to say but difficult to put intopractice”. A minority disagreed with the proposal on the basis that the problemswould be too great.

2.126 The first difficulty raised was proving what an insurer would have done had itknown the information. The ABI commented that there were many ways in whichan insurer might have reacted, and the test could not deal with every possibleeventuality. Insurers would be left re-rating the claim with hindsight, after the losshad occurred. The Liverpool Underwriters and Maritime Association agreed thatthe proposal would “increase post loss underwriting”. It would also “requirevoluminous disclosure to be given, contrary to the CPR [Civil Procedure Rules]”.Lloyds pointed out that this would be a particular problem where the court rejectsan insurer’s argument that it would have declined the policy. The court will thenbe left with no evidence about what an appropriate premium may have been.

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2.127 Several life and protection insurers asked what would happen if the insurer wouldhave postponed a decision pending further tests. In these circumstances, thecourt or ombudsman would need to go on to ask what the result of the test wouldbe likely to be. The ABI pointed out that it is not always possible to answer thisquestion with precision. For example, if a customer had a history of sexuallytransmitted infections the insurer may have asked for an HIV test. It may not bepossible to know what the result would have been: “having a positive HIV test atthe point of claim is not proof that the customer was positive at the point ofproposal”. Our view was that there would be some uncertainties of this sort, butthat the problem would not be overwhelming.

2.128 Friends Provident pointed out that proportionate remedies may lead to arbitraryresults, when seen from a consumer’s point of view. For example, insurers oftenmake premium additions for mild cases and exclusions for more seriousproblems. This means that if two people make identical misrepresentations, theperson with the mild case may receive only a proportionate settlement, while theperson with the more serious case may have an unrelated problem and be paidin full. We would reply, however, that results of this type occur whenever the lawcompensates the victims of negligence. The amount is based on the victim’s loss,and may have little to do with the extent of the perpetrator’s fault.

2.129 K&L Gates, a solicitors’ firm who only represent policyholders, were concernedabout limb 3. This allows insurers to avoid when they can show they would nothave accepted the risk at all. They thought that insurers should always producesupporting evidence for such a claim.

2.130 Several insurers thought that proportionate payments under limb 4 were suitablefor minor increases in premium, but would give insurers inadequatecompensation where the premium would have been increased substantially.

Aviva believes these proposals present a reasonable approach wherethere is an honest but negligent misrepresentation, which results in asmall additional premium. However, Aviva is slightly concerned about“fronting” cases where the premium could be 2 or 3 times what theclient originally paid. [Aviva]

There should be consideration of a threshold above which the claimshould be denied. It is not fair to charge honest applicants rated termsand allow others to be no worse off in all the circumstances even ifthere is a negligent misrepresentation. For example, life insurersshould not be expected to treat someone whose premium should berated at up to +50% extra mortality the same as someone whosepremium would be rated at +400% extra mortality. [ABI]

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2.131 The advantage of proportionate payments is that the effect of themisrepresentation on the insurer is directly related to the size of the payment.Take a case where a consumer insured their life for £100,000 and paid apremium of £500. If the premium ought to have been 50% higher (that is, £750),the consumer has paid only two-thirds of the correct premium and hence will beentitled to only two-thirds of the sum assured (£66,667). If, however, the premiumshould have been 400% higher (that is, £2,500), then the consumer has paid onlyone-fifth of the correct premium and accordingly will be entitled to only one-fifth ofthe sum assured (£20,000). This means that those who make more significantmisrepresentations will receive substantially less in payment, without the need foran arbitrary threshold.

Overview of responses 2.132 Proportionate remedies are now an accepted part of FOS decisions, and are

widely regarded as workable and just. In some cases it will not be possible to saywhat the insurer would have done with scientific precision and the court orombudsman will need to make their best estimate. However, courts andombudsmen are used to this. It occurs wherever the law attempts to put people inthe position they would have been in had an event not taken place. It may bebetter to aim imprecisely at the right target than to aim precisely at the wrongone, as avoidance does.

CLAIMS THAT ARE UNRELATED TO THE MISREPRESENTATION 2.133 The compensatory approach considers what the insurer would have done had it

known the information at the time of underwriting. It does not look at whetherthere is any causal link between the misrepresentation and the claim. Forexample, if an insurer would have charged three times more for a buildingsinsurance premium had it known of a flood risk, it will only have to pay a third of aburglary claim. It is irrelevant that the burglary was completely unconnected tothe risk of flooding.

2.134 In the Consultation Paper we considered – and rejected – an alternativeapproach, which would have looked at whether there was a causal connectionbetween the misrepresented information and the claim (CP para 12.22). This isthe approach in some other European systems. The Restatement of EuropeanInsurance Contract Law, for example, gives the insurer a remedy only “if aninsured event is caused by an element of the risk that is the subject of negligentnon-disclosure or misrepresentation by the policyholder”.19

19 Draft 17 December 2007, art 2:102(5).

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2.135 We acknowledged that denying claims for unrelated issues may sometimes seemunfair. For example, if a policyholder dies in a rail crash, it can appear distastefulfor the insurer to trawl through medical notes looking for a careless omissionabout anti-depressants. However, we did not think that requiring a causalconnection was practical. Many questions are about criminal records or previousclaims. Although the fact that someone was involved in a motor accident last yeardoes not cause an accident next year, it is still highly relevant to the risk.Similarly, an insurer may find information about previous depression relevant tothe risk of serious illness without being able to prove a causal link betweendepression and cancer.

2.136 Almost everyone who addressed the causal connection point agreed with us thata causal connection should not be required between the misrepresentedinformation and the claim.20 The exception was Ray Hodgin of the University ofBirmingham, who argued that the negligence could be minor and theunconnected claim may be major: “it seems unfair that the insurer should be ableto escape all payments”.

2.137 The National Consumer Council also thought that allowing insurers to avoid forunconnected reasons could lead to some harsh decisions. They agreed with usonly on condition that there was a discretion to prevent clear injustice: otherwiseit may be necessary to reconsider imposing a causal connection requirement.

IS THERE A NEED FOR A JUDICIAL DISCRETION? 2.138 In the Consultation Paper, we argued that in general a compensatory approach

would be fair between the parties. However, we pointed out that it may operateharshly in some cases.

2.139 One problem is that where an insurer would have declined the risk, the policy isavoided. However, another insurer may have accepted the risk for only a smallincrease in premium. Similarly, the misrepresentation may have nothing at all todo with the claim. We thought this problem would be compounded where themistake was negligent but the consumer would be regarded as acting excusablyin their particular circumstances.

2.140 We gave the example of a recently bereaved widow who failed to notice signs ofsubsidence. This may have been negligent but totally understandable in thecircumstances of her individual case. We commented that it would be reasonablefor an insurer to refuse to pay a subsidence claim that it would never have takenon had it known. However, our proposals mean that if the insurer shows that hadit known about the subsidence it would not have written the policy at all, it mayrefuse to pay her burglary claim. This might be thought by some to be overlyharsh.

20 However, several respondents said they did not understand the question. A few misread it:they thought we had proposed a causal connection test, rather than rejecting one, and theyargued against such a test.

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2.141 We therefore asked whether there was a case for granting the courts orombudsman some discretion to prevent avoidance where the insurer would havedeclined the risk but the policyholder’s fault was minor, and any prejudice theinsurer suffered could be adequately compensated by a reduction in the claim(CP para 12.20).

Responses 2.142 Out of 64 responses to this question, around 40% answered that a discretion was

necessary. Some consumer organisations thought that it was needed to off-setpotential injustices in our proposals. Age Concern thought that “the discretionwould go some way towards balancing any unfairness that might arise from adefinition of ‘unreasonableness’ that ignored personal circumstances”. Similarly,the National Consumer Council thought that it was important where the insurerrefused a claim for unconnected reasons.

2.143 Some people thought that a new statutory discretion was unnecessary. The FOSpointed out that it already had “an overriding obligation to reach a decision that isfair and reasonable”. Effectively, therefore, it could operate such a discretioneven if it was not specifically included in legislation. Professor John Lowrythought that the courts could come to a similar result by finding that “good faithapplies to the exercise of this remedy”.

2.144 However, the majority of respondents opposed the discretion in principle. Mostinsurers and insurance organisations thought that it would introduce uncertaintyand lead to unacceptable interference with insurers’ freedom to write business.For example, BILA described our proposal as an “uncertain test, which will leadto fewer cases settling”. The ABI said it would “effectively allow interference withinsurers underwriting practices”. Zurich Financial Services said that it was notclear what effect this would have on reinsurance.

2.145 Many respondents found it difficult to understand how it might operate. Forexample, Lord Justice Rix thought that there might be a case for some discretion,but it “should be narrowly confined, e.g. where the loss is unrelated to the faultand the fault does not extend to fraud or recklessness”. However, he criticisedthe formulation set out in the Consultation Paper:

It is not clear how, on the hypothesis that the insurer would havedeclined the proposal, the insurer “could be adequately compensatedby a reduction in the claim”. I agree that the case where the insurer inparticular would have declined the claim, but his competitor would not(but would have raised the premium, etc) may need some specialrule, at any rate in cases of hardship. [Lord Justice Rix]

Overview of responses 2.146 Consumer groups generally welcomed the proposed discretion, while most

insurers opposed it. The FOS saw it as unnecessary, as the FOS already has adiscretion to reach decisions that are fair and reasonable.

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The ABI Guidance 2.147 The ABI Guidance on Non-Disclosure and Treating Customers Fairly issued in

January 2008 raises several cases where the industry thinks it would be unfair toreject claims, even if this would be the result of applying a compensatory remedy.The most obvious case is where an insurer goes on a “fishing expedition” formisrepresentations that are unconnected with the claim. The example given inthe Guidance is Case 2, where a man takes out life insurance and is then killed ina traffic collision. The Guidance spells out that where there is no evidence tosuggest that the customer had a contributory medical condition, the insurershould pay the claim. It should not look through medical records to see whetherthe insured had failed to disclose some unconnected medical condition.

2.148 We can see that fishing expeditions of this sort cause public disquiet. It seemswrong that insurers should “underwrite at claims stage” by trawling throughunconnected issues. However, under the strict regime we have set out above, theinsurer would be entitled to point to an unconnected careless error. If, forexample, the insurer can show that if questions about family history or weightwere answered incorrectly, it can adduce evidence of what the insurer wouldhave done had it known the correct information. If the insurer would haveincreased the premium, it may pay only a proportion of the claim. If it would havedeclined cover, it may refuse the whole claim.

2.149 The ABI Guidance deals with this issue as a matter of evidence: the insurer maynot rely on medical information that has been wrongly obtained. However, wethink it will be difficult to set hard rules about what evidence may be used,especially where a doctor has sent more information than was asked for. If theindustry thinks that it would be wrong to deny a claim for a death in a trafficcollision for unconnected misrepresentations (despite the fact that it tells us that acausal connection test is the wrong one), then we ask whether it would be betterto provide a discretion to address this issue.

2.150 Similarly, the ABI acknowledges that it seems unfair to reduce claims as a resultof questions that address different risks. Case 11 gives an example where awoman takes out critical illness insurance with total permanent disability benefit(TPD). She fails to mention a history of back problems, which was relevant onlyto the TPD, and then submits a valid claim for breast cancer. The Guidancesuggests that the TPD should be treated as severable, so that amisrepresentation in connection with the TPD should not affect the cancer claim.However, as a matter of strict law the TPD element may not necessarily beseverable in this way. It would depend on the construction of the particular policy.

2.151 Surprisingly, the ABI suggests that the claims should be paid even where themisrepresentation is dishonest. As already discussed, the Consultation Paperargued against a lenient approach to those who act dishonestly. However, wethought that there is a case for leniency for excusable errors. The ABI Guidanceis clearly attempting to find ways to mitigate harsh results when claims would bedenied or substantially reduced for reasons unconnected with the claim. Furtherthought needs to be given to whether these initiatives should be built into ourproposed scheme, and if so, how this might best be done.

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CANCELLING FOR THE FUTURE 2.152 In the Consultation Paper we briefly considered the effect of a misrepresentation

on future cover.

2.153 We thought that where an insurer would have declined cover, the policy shouldbe avoided, and the premium returned (as happens at present). However, wherethe insurer would have offered the policy on different terms, we preferred thecurrent FOS practice to the strict letter of the law. The FOS generally allows theconsumer a choice. For an inadvertent misrepresentation, the policy may beavoided and the premium returned. Alternatively, the cover may continue onamended terms. For example, the consumer may pay an additional premium.Alternatively, the cover may continue for the same premium, but subject to anexclusion. We pointed out, however, that this would not prevent the insurer fromrelying on a more general contractual right to cancel on notice (CP para 12.21).

2.154 This proposal drew relatively little comment. Most issues of misrepresentationarise in the context of claims, and disputes about future cover are relatively rare.Only 51 consultees addressed the issue, and of those who did, two thirds (67%)simply agreed without comment.

2.155 A minority of insurers opposed the proposal, on the grounds that insurers shouldnot be forced to contract with those who have behaved negligently.

NEGLIGENT MISREPRESENTATIONS IN LIFE POLICIES: SHOULD THELAW IMPOSE A CUT-OFF PERIOD?

2.156 Particular problems may arise in long-term business where many years mayelapse between filling in the proposal form and making the claim. In theConsultation Paper, we noted that many jurisdictions dealt with this issue byimposing cut-off periods. This means that the insurer is prevented from relying ona non-fraudulent misrepresentation at the applications stage once the policy hasbeen in force for a set period – usually between two and five years.

2.157 In our first issues paper, we asked whether insurers should be prevented fromrelying on non-fraudulent misrepresentations after the policy has been in force forthree years. This drew strong reactions, both for and against. Some argued that itwould increase consumer confidence. Others thought it would encourage fraud,increase costs and lead to inconsistent treatment between consumers.

2.158 We were told that at present most life insurers do not investigate non-disclosuresmade more than five years previously in the absence of evidence of fraud. It wassuggested that it would increase consumer confidence to have this good industrypractice built into law, without adding substantially to costs. On this basis weasked whether in consumer life insurance, insurers should be prevented fromrelying on a negligent misrepresentation after the policy has been in force for fiveyears (CP para 12.23).

Responses 2.159 Respondents were again split on this issue. Of the 61 consultees who addressed

this issue, 34 were in favour; 24 thought that there should not be a cut-off period;while three would have preferred the shorter period of three years.

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2.160 The FOS commented that they did not think this proposal would have asignificant effect if the other proposals were enacted. However, they did seesome benefit:

It would serve as an additional safeguard for consumers, knowingthat their cover would enjoy extra certainty after five years. It wouldalso serve as a practical safeguard against insurers wrongly disputingclaims after five years and relying on consumers and their executorsor relatives having the capability and fortitude to challenge them.[FOS]

2.161 Some insurers gave tentative agreement, on the basis that the proposal did notextend to fraud, only applied to life cover, and was five years (rather than theoriginal three). Aegon UK, for example said there would have to be a very cleardefinition of consumer life insurance, especially in umbrella policies. Scottish Resaid they would agree with this proposal provided that it was made absolutelyclear that deliberate or reckless misrepresentations remained actionable after fiveyears, and that where the insurer asked a clear question the proposer should betaken to know the fact was relevant. In these circumstances, they did not thinkthe proposal would lead to consumers taking calculated risks in not disclosingillnesses.

2.162 However, a majority of insurers (including most life insurers) opposed theproposal, on the grounds that it would lead to more misrepresentations in lifepolicies and increase costs.

2.163 Insurers feared the effect of such a rule on consumer behaviour. For exampleScor Global Life accepted that it was already standard practice in the life industryto disregard minor matters if the policy has been in force for five years or longer.However, it was hard to predict how consumers would react if this was known tobe a hard and fast rule. Given the difficulties of costing the effect, it was better notto take the risk. Similarly Friends Provident said that the FOS had sometimesapplied a five-year cut off. However, it was very different for the FOS to do thisbecause it was fair and reasonable in the individual case and for the courts to doit as a matter of law.

2.164 Some argued that there was no logic to apply more restrictive tests to lifeinsurance than to other long term insurance, including critical illness and incomeprotection. Others, however, suggested that fraud was more of a problem inrelation to critical illness and income protection insurance because the insuredwas alive to enjoy the benefits of it. Insurers therefore needed greater protectionin relation to these policies.

NO CONTRACTING OUT

Mandatory rules for consumer insurance 2.165 In the Consultation Paper we argued that insurers should not be entitled to give

themselves greater rights to reject claims for non-disclosure andmisrepresentation by adding terms to their contract to this effect. We provisionallyproposed that it should not be possible to contract out of the consumer rulesgoverning misrepresentation and non-disclosure in consumer insurance except infavour of the consumer (CP para 12.24).

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2.166 Almost everyone who responded to this question agreed. The FOS described itas “an essential element of the reform”.

Statements of past and present fact 2.167 The strict letter of insurance contract law allows insurers to increase their legal

rights for misrepresentation by using warranties of existing and past fact. If apolicyholder agrees to a contractual term that warrants that a fact is true, theMarine Insurance Act 1906 provides that the insurer is automatically dischargedfrom liability under the policy if the fact is untrue.21 This may occur even if thewarranty is immaterial and given in good faith.

2.168 Historically, insurers used these terms to increase their rights. In particular, thelaw allowed insurers to turn all the facts given on an application form intowarranties by stating that these form “the basis of the contract”. In law, the effectof a “basis of the contract” clause was that any mistake on the form, howeverinnocent and however immaterial, would entitle the insurer to refuse all claims.22

2.169 It is now generally accepted that in the consumer market insurers should not relyon basis of the contract clauses. In 1986 the ABI Statement of General InsurancePractice barred their use, and the FOS would reject any defence based on them.Although the FSA rules do not specifically mention basis of the contract clauses,the ABI has confirmed to us that it would consider the use of such clauses tocontravene insurers’ duty to treat customers fairly.

2.170 We thought that the law should be reformed to prevent insurers from usingwarranties of past or present fact or basis of the contract clauses to add to theirrights for misrepresentation. We provisionally proposed to follow the Australianapproach, which provides that a statement by the insured about past or presentfact takes effect as a representation rather than as a warranty (CP para 12.25).

Responses 2.171 The great majority of respondents agreed with us. Out of 57 responses, 53 simply

agreed without comment.

The ABI, Fortis Insurance Ltd and ACE European Group disagreed. They thoughtthat insurers may want to include warranties for past or existing facts for goodreason, though they did not give any illustrations. We find it difficult to think ofexamples where characterising a statement of past fact as a warranty would beboth helpful to the insurer and fair to the policyholder.

Overview of responses 2.172 There is a widespread consensus in favour of making the consumer regime

mandatory, in the sense that insurers will not be entitled to contract out of itexcept in favour of the consumer.

21 Marine Insurance Act 1906, s 33.22 Dawsons Ltd v Bonnin [1922] 2 AC 413; 1922 SC (HL) 156.

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PART 3GROUP INSURANCE, CO-INSURANCE ANDINSURANCE ON THE LIFE OF ANOTHER

GROUP INSURANCE 3.1 In the Consultation Paper, the Law Commissions discussed how issues of non-

disclosure should be treated in relation to group schemes. We focused on groupinsurance provided by employers for their employees. This is an important formof protection insurance: nearly 40% of life cover, for example, is provided throughsuch schemes. Yet the legal principles that apply to such schemes are uncertainand under-developed. Our objective was to bring the law into line with the FOSapproach and accepted practice in the market.

3.2 Our proposals made a sharp distinction between representations made by thepolicyholder (usually the employer) and those made by individual group members(as where an employee fills in a health declaration form). We thought that wherethe employer failed to provide correct information, it should be treated under thebusiness scheme.

3.3 However, we proposed that where a misrepresentation was made by a groupmember (such as an employee):

(1) It should have consequences only for the cover of that individual. Itshould not, for example, invalidate claims by other members of thegroup; and

(2) Any dispute should be determined in accordance with our proposals forconsumer insurance. Thus if a group member had misrepresented theirhealth on a declaration form, the court or ombudsman should askwhether the misrepresentation was innocent, negligent ordeliberate/reckless (CP para 12.44).

Misrepresentations by individual group members

Applying consumer-type remedies 3.4 Most respondents agreed with our proposals. Out of 46 respondents, over half

(54%) agreed without comment. The FOS said that the proposal reflected currentmarket practice, which it has adopted.

3.5 By contrast, the ABI thought there was no need for reform, as the current legalsituation was satisfactory. They said:

On the basis that the proposals are already market practice, we areunconvinced that the case has been made for any reform orintervention by the Law Commission. Further, we are keen to protectinsurers' freedom of contract in negotiating more tailored remedies.[ABI]

They were supported in this by three other insurers.

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3.6 No one argued that a misrepresentation by an individual member should affectothers within the group. However, a handful of insurers expressed unease abouttreating misrepresentations by group members under the consumer regime. Forexample, the Investment and Life Assurance Group (ILAG) commented that “thedispute should not be dealt with under consumer insurance rules as the employer– not the employee – is the policyholder”. Scottish Widows thought that treatinggroup members as consumers would create practical difficulties:

This scenario expects a life office to be able to readily switch betweeninsurance regimes. In practice, this will only create unnecessaryadministrative confusion with resultant delay or complaint over thehandling of a claim. [Scottish Widows]

3.7 The Group Risk Development Group (GriD) also thought that it would createconfusion and administrative delays, as the policy itself is business insurance.

Free cover 3.8 In the Consultation Paper we asked what should happen where a group member

made a deliberate or reckless misrepresentation, but the insurer would havegiven a certain level of “free cover” without that information. Should the insurer beentitled to refuse all benefits in respect of that member? Alternatively, should thelaw support current practice? This provides the member with the so called “freecover” that would have been provided in any event, provided the basic eligibilitycriteria for the scheme are met (CP para 12.45(1)).

3.9 Only a few respondents addressed the issue, and among those who did, viewswere fairly evenly divided. Nine respondents argued that where the member hasmade a deliberate or reckless misrepresentation, the insurer should be entitled torefuse all benefits in respect of that member. Eight respondents agreed with thealternative option of providing the free cover subject to satisfying the eligibilitycriteria for the scheme.

3.10 The FOS thought that free cover should be given:

If the insurer would have provided a certain level of free cover in anyevent in respect of that member without underwriting, then arguably,there is no “inducement” in respect of that free cover, and the insurershould not be able to rely on non-disclosure to avoid that element ofcover. [FOS]23

3.11 However, the Faculty of Advocates believed that insurers should not becompelled to make provision for the minimum free cover, even though it is donein practice:

23 This would be true only if the free cover and extended cover were in separate or severablepolicies. If the policy were treated as a whole, then there would be inducement if theinsurer had offered different terms, such as a greater level of cover.

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The insurer should not be compelled to make such provision. “Freecover” is only “free” in one sense. In another sense, it costs theinsurer. In our view, the insurer should continue to have discretion indealing with such circumstances, and should continue to be entitledto refuse all benefits in respect of that member. This promotesconsistency of treatment in relation to deliberate or recklessmisrepresentations made by any proposer. We would not expect the[current] accepted practice necessarily to change. [Faculty ofAdvocates]

3.12 Friends Provident also said that they do not want a law requiring free cover to begiven. They would still honour claims for free cover in such circumstances.

However, to make a law requiring this to be done would set aprecedent which is inconsistent from the general message of this newlegislation. [Friends Provident]

3.13 The Liverpool Underwriters and Marine Association believe that this proposaloffends Lord Hobhouse’s comments made in the case of The Star Sea: “thefraudulent insured must not be allowed to think: if the fraud is successful, then Iwill gain; if it is unsuccessful, I will lose nothing”.24

Overview of responses 3.14 Most people agree that if a policyholder has made a misrepresentation to a group

insurer, the ombudsman should apply normal consumer-type remedies. Thiswould involve, for example, providing proportionate remedies for negligentmisrepresentations and avoiding the policy for deliberate/reckless ones.

3.15 Some insurers expressed concern that group insurance should not be treatedunder the consumer regime. However, they did not appear to be suggesting thata group member should, for example, be required to volunteer information in thesame way as a business policyholder. Rather insurers seemed to be expressinga more general concern that if group members were treated as consumers forthis purpose, then other elements of consumer regulation would be imposedupon them. This was not our intention. We were not saying that group insuranceis consumer insurance – simply that the insurer’s remedies against a groupmember for a misrepresentation should be similar to the one we have proposedfor consumers. Most people thought that the FOS practice of treating groupmembers in this way works well, and should be supported by statute.

3.16 The arguments over “free cover” are finely balanced, and there was no clearconsensus on this issue.

24 Manifest Shipping Ltd v Uni-Polaris Insurance Ltd – the ‘Star Sea’ [2001] 1 Lloyd’s Rep389 at 403.

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Misrepresentations by the policyholder (employer) 3.17 Under our reforms, if the policyholder makes a misrepresentation or non-

disclosure, it would be regarded as a commercial matter and dealt with under thebusiness regime. In our Consultation Paper we asked if consultees agree that anon-disclosure or misrepresentation by the policyholder should provide theinsurer with the same rights to avoid a policy as would apply to other businessinsurance (CP para 12.45(2)).

Arguments in favour of applying a business regime 3.18 The majority of the respondents agreed that the insurer should still have the right

to avoid. Aegon UK argued that this is a vital remedy as

a non-disclosure/misrepresentation by the policyholder could have afundamental impact on an insurer in financial terms. [Aegon UK]

3.19 ILAG believed that businesses should be held to a higher standard thanmembers under a group scheme, on the basis that:

the employer should be expected to have greater knowledge than thegroup member does. [ILAG]

3.20 GRiD also agreed, but pointed out that it “could leave all employees under thepolicy without cover, which could have other far-reaching implications”.

Arguments against applying the business regime 3.21 Eleven respondents disagreed with this proposal, on the grounds that it would

have an unduly harsh impact on employees. They feared that employees wouldbe deprived of cover by mistakes that are not their own. As K&L Gates put it:

It would seem excessively harsh on the employees for them to loseany potential benefits under the policy as a result of amisrepresentation or non-disclosure of which they were unaware andover which they had no control. [K&L Gates]

3.22 The FOS believed that all employee benefits under a group scheme should beprotected where an employer has made a misrepresentation or a non-disclosure:

Where the insurer has with the knowledge of the employer held theinsurance out to the employees, as being for their direct benefit thenthe employee's right to claim under the policy should not be affectedby the employer's misrepresentation or non-disclosure. The insurerwould no doubt seek to recover its liability to employees in thesecircumstances from the employer under the terms of the policybetween them. [FOS]

Overview of responses 3.23 Some group schemes cover thousands of employees. If an insurer were to avoid

such policies the results could be serious, as many employees would findthemselves without cover through no fault of their own. They may well have aclaim against their employer, but this will not help them if the employer becomesinsolvent.

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3.24 However, the same problems arise for third party claimants in many situations.Most respondents did not think this was a problem that could be solved bycontract law. Insurers were concerned about any suggestion that they might losethe right to avoid a policy against an employer who breached their duty ofdisclosure.

Other types of group insurance 3.25 In the Consultation Paper, we asked consultees if they were aware of problems in

other types of group insurance, which were not linked to the employer/employeerelationship. We asked whether similar rules should also apply to those types ofgroup scheme (CP para 12.46).

3.26 Several respondents mentioned group schemes that only apply in the businesscontext (such as construction policies, P&I policies and parent and subsidiarypolicies).

3.27 The only types of policy mentioned that are relevant in the consumer field wereblock building policies. The FOS said that they occasionally consider complaintsfrom tenants who benefit from block building policies, where the tenant’s interestis noted on the policy. In those circumstances they treat the tenant as thoughthey had arranged the insurance directly with the insurer (that is as a consumer)even though the actual policyholder tends to be a limited company. FriendsProvident also mentioned these types of policy.

CO-INSURANCE 3.28 In the Consultation Paper we explained that the current law draws a distinction

between “joint” policies and “composite” policies. Co-insureds under a joint policystand or fall together. However, where a policy is composite, an innocent co-insured is unaffected by their co-insured’s misrepresentation.

3.29 We said that we would return to this distinction when we looked at fraudulentclaims. However, in the context of pre-contractual information we did not proposeany changes. We asked consultees if they were aware of any problemsconcerning the law of co-insurance in relation to issues of non-disclosure andmisrepresentation (CP para 12.47).

Agreement 3.30 Out of the 35 respondents who gave their views on this question, most said that

there are no problems with this area of law. Scottish Widows and Allianz saidthey did not want to see any changes being made. The National ConsumerCouncil also said that the current law is satisfactory:

The law in this area is probably satisfactory and those consumer co-insureds will be protected sufficiently by the proposed reforms forconsumer insurance generally. [NCC]

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Problems with the current law 3.31 Several people raised difficulties with the joint/composite distinction. Professor

Robert Merkin argued that there are “massive problems”. He raised doubts aboutwhether the co-insurance rule applies to warranties, and thought that Arab Bankv Zurich Insurance Co25 did not resolve the issue. There were regular difficultiesin the professional indemnity market:

It is necessary to decide who knew what, whether that person’sknowledge is imputed to other co-assureds and whether the positionis different where the person who signs the proposal form is himself inpossession of material facts. [Professor Merkin]

3.32 Several other respondents, including the Bar Council’s Law Reform Committeealso highlighted the problems that can arise in professional indemnity anddirectors’ and officers’ liability policies. As far as consumers were concerned, AgeConcern raised possible problems with travel insurance.

3.33 The ABI thought that the law was satisfactory, but said the issue was of growingimportance where unrelated individuals bought homes together. One respondentsaid that it was unclear whether such a policy would be joint (as joint or co-owners of the property) or composite (having separate possession).

Overview of responses 3.34 The distinction between joint and composite insurance is a difficult one. However,

most of the problems arise in business insurance, particularly in professionalindemnity and directors’ and officers’ liability policies. We shall be returning to theissue in the context of fraudulent claims and business insurance. Most people didnot think that there was an urgent need for reform in the context of consumermisrepresentations.

INSURANCE ON THE LIFE OF ANOTHER

Consumer life-of-another policies: misrepresentations by the life insured 3.35 This issue arises where the consumer policyholder takes out insurance on

another person’s life. The person whose life is being insured is asked questionsabout their age and state of health and the insurer relies on that information whenwriting the risk. However, the life insured is not a party to the contract. Thismeans that if the life insured makes a misrepresentation the insurer would notnormally be entitled to a remedy unless the policyholder knows of it.

3.36 Insurers frequently protect themselves by requiring the policyholder to agree thatthe life insured’s answers form “the basis of the contract”. However, this goesfurther than necessary to protect the insurer’s legitimate interest: it means thateven an innocent or reasonable mistake would prevent the policyholder fromrecovering. As already discussed, there was overwhelming support for abolishingbasis of the contract clauses. If they are abolished, insurers would need someother form of appropriate protection.

25 [1999] 1 Lloyd’s Rep 262.

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3.37 In the Consultation Paper, we said that in the absence of an agreement to thecontrary, the policyholder should bear the risk that the person whose life isinsured has acted negligently or dishonestly. Therefore, we provisionallyproposed that in consumer life-of-another policies, representations by the life tobe insured should be treated as if they were representations by the policyholder.If the insurer can show that either the life insured or the policyholder (or both)behaved deliberately, recklessly or negligently, it will have the remedy that isappropriate for that kind of conduct (CP para 12.48).

3.38 All of the 35 replies we received agreed with the proposal.

Parallel issues in other consumer contexts 3.39 In the Consultation Paper, we asked consultees whether parallel issues arise in

other consumer contexts and, if so, whether the same solution is appropriate (CPpara 12.49).

3.40 The ABI pointed out that problems might arise where there are additional driverson motor policies and the driving history of those drivers has to be obtained andprovided by the policyholder. The extent of the policyholder’s knowledge of thedriver’s true history will vary from case to case.

It may be useful to clarify the position of persons who are not thecontracting party but who may be entitled to an indemnity and inrespect of whom information is provided to the policyholder. [ABI]

3.41 Munich Re UK Life Branch said problems can arise with policies written undertrust. In those circumstances they suggest that the same solution should alsoapply.

Overview of responses 3.42 Everyone agreed that representations by the life to be insured should be treated

as if they were representations by the policyholder. It was suggested that similarproblems might arise in other areas, such as motor insurance which coversnamed drivers who are not parties to the contract.

CONSUMER INSURANCE: “JOINT LIVES, FIRST DEATH” POLICIES 3.43 An example of a “joint lives, first death” policy is where spouses take out a joint

policy on each other’s lives to be paid out on the first person’s death. Problemsarise when one spouse makes a deliberate misrepresentation without the otherparty’s knowledge. Under current law and ombudsman practice, the insurer mayrefuse the claim irrespective of which party survives and makes the claim. In ourConsultation Paper we asked whether consultees agreed that in a “joint life, firstdeath” policy, the insurer should be entitled to refuse claims where either thedeceased or the beneficiary has made a deliberate or reckless misrepresentation(CP para 12.50).

3.44 Thirty-three respondents gave their views on this question and almost all of themagreed with this proposal. Aegon UK said that it should make no difference as towho made the misrepresentation:

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One policyholder should be tainted by the actions of the other(whether or not the insurer may decide to pay a claim where it wasthe beneficiary that made the misrepresentation should be left to thediscretion of the insurer). [Aegon UK]

Continuing the policy for the innocent party 3.45 At present, when the guilty party dies and the claim is rejected, the FOS may use

its discretion to order the insurer to continue the policy on the life of the innocentparty. We asked whether this should continue within a statutory scheme. Shouldthe court or ombudsman have discretion to order the insurer to continue thepolicy as a single life policy, payable on the death of the innocent party (CP para12.51)?

3.46 Of the 35 respondents answering this question, two-thirds agreed that the courtor the FOS should be given discretion to adjust joint life policies in this way.

3.47 Scor Global Life agreed with this proposal in principle, but pointed out thatvarious practical issues may arise. They believe the court and the FOS wouldneed to consider factors such as premium rates and terms of cover beforemaking such an order, bearing in mind that the rates and terms of the originalpolicy may not be appropriate.

3.48 One broker believed that consideration should be given to a refund of thepremiums relating to the party whose life insurers have declined to pay to theparty who was expecting to receive the benefit of the policy. The City of LondonLaw Society made the same point:

The court or ombudsman should have the alternative of ordering areturn of the premium or the policy value to the survivor, subject toany tax implications. [City of London Law Society]

Overview of responses 3.49 There was general support for the view that in a “joint life, first death” policy, the

insurer should be entitled to refuse claims where either the deceased or thebeneficiary has made a deliberate or reckless misrepresentation.

3.50 There was less agreement about what should happen following the guilty party’sdeath. Some thought that the policy should be extended on the innocent party’sown life, while others thought that the premiums should be returned to thesurvivor.

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PART 4WARRANTIES AS TO THE FUTURE

INTRODUCTION 4.1 In our Consultation Paper, we divided our discussion of warranties into two parts.

We considered warranties of past or present fact alongside other forms of pre-contract information. We have already summarised the responses we receivedon this issue.

4.2 Warranties about future conduct were discussed in Part 7 of the ConsultationPaper and our detailed provisional proposals were set out in Part 8. By and large,we proposed dealing with future warranties in the same way in both business andconsumer policies, and our provisional proposals often did not distinguishbetween the two.

4.3 Future warranties are much more important in commercial policies than inconsumer policies, and most people who considered our reforms on futurewarranties addressed them from a business point of view. We will thereforepublish a more detailed account of responses on our future warranty proposals inour next Summary Paper, which will deal with our business proposals.

4.4 The current team view is that we should not reform the law of warrantiesseparately for consumer insurance. Instead, the issue should be addressed forboth consumers and businesses together. Below we provide a brief description ofour proposals on this issue, and our reasons for looking at warranties on acombined basis across both consumer and business insurance.

WHAT IS A WARRANTY? A WIDE OR NARROW DEFINITION 4.5 As we explained in our Consultation Paper, the same obligation can be phrased

in different ways. A consumer may “warrant” to fit (and use) a mortice deadlock:alternatively, the policy may exclude burglary claims unless a mortice deadlockwas fitted (and in use) at the time of the loss. Under strict law these twoprovisions have different consequences.

(1) The first may be considered a warranty. If so, section 33 of the MarineInsurance Act 1906 provides that if the policyholder commits a minorbreach (by for example fitting the lock a week after the promised date)the insurer is discharged from all future liability under the policy. Theinsurer would not be liable for a subsequent burglary, even if the morticelock had been fitted by the time the burglary took place.

(2) The second approach would be a “temporal condition”. The insurer couldonly refuse to pay a claim if it could show that the lock was not in use atthe time of the burglary. However, it would not have to show that the lackof a lock made any difference. It could refuse a claim even if the burglarshad climbed in through a smashed window.

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4.6 It has long been accepted that the strict legal consequences of a breach ofwarranty would be overly harsh if applied to consumers. In 1986, the ABIStatement of Practice provided that insurers would not reject a claim unless thecircumstances of the claim were connected to the breach. This now forms part ofthe FSA rules.26

4.7 Technically, the FSA requirement for a causal connection between the breachand the loss only applies to warranties in the strict sense. However, the FOS hasinterpreted its spirit more widely, to apply to temporal exclusions as well. In theConsultation Paper we quoted a case where the complainant claimed for a stolenbicycle that had not been locked at the time. Although the requirement for a lockhad been phrased as a temporal exclusion rather than a warranty, theombudsman allowed the claim on the grounds that the lock would not have madea difference. The circumstances of this particular claim were not causally relatedto the breach.

4.8 We thought that insurers should only be entitled to refuse claims for breach ofwarranty if there was some causal connection between the breach and the loss.The more difficult decision, however, was whether this reform should only applyto warranties in the strict sense, or whether it should also apply to terms that hadthe same effect.

The Issues Paper approach: a wide definition 4.9 In Issues Paper 2, published in November 2006, we thought that a causal

connection should be required not only for warranties but also for terms that hadthe same effect. We suggested following the Australian model. This applies arequirement for a causal connection to all exclusions based on acts or omissionsby the insured that “could reasonably be regarded as capable of causing orcontributing to a loss”.27

4.10 However, we accepted that some provisions were so important that thepolicyholder should not be able to claim even if the loss were not connected withthe breach. These might include, for example, provisions about whether a carwas used for private or business purposes; about the age or identity of a driver;or the geographic area in which the loss took place. We tentatively proposed thatthese terms should be specifically excluded from the requirement for a causalconnection. Many of those responding to the Issues Paper thought theseproposals were unduly complex and arbitrary.

The Consultation Paper: a narrow definition, coupled with a “reasonableexpectations” approach

4.11 In the Consultation Paper we proposed a different approach. We said that thecausal connection test should be confined to warranties in the strict sense.

26 ICOB Rule 7.3.6, now replaced by ICOBS 8.1.2(3).27 Insurance Contracts Act 1984, s 54.

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4.12 Other terms have the potential to be similarly unfair. However, for consumerpolicies we thought such problems could be dealt with by the Unfair Terms inConsumer Contracts Regulations 1999. These already provide the courts and theFOS with extensive powers to review the fairness of exclusions. We thought thatthe main problem was for small and medium businesses that contracted on theinsurer’s standard terms. We therefore proposed that the court should reviewstandard terms in business contracts if they would undermine the policyholder’sreasonable expectations.

4.13 Several of those responding to the Consultation Paper felt that this was thewrong decision. They disagreed with all our proposals on warranties becausethey believe that terms that have the same effect should be treated in the sameway. This point was strongly put forward by academics. Professor Robert Merkinand Professor John Lowry wrote:

In our view it makes sense for clauses with the same objective to beregulated in the same way, and indeed any attempt to ban aparticular form of clause may well lead to insurers adopting anotherform of clause to the same effect. It makes particular sense forinsurers not to use clauses which have consequences far beyondtheir purpose, a warranty being the obvious example of thatpossibility. Our starting points are, therefore, that: clauses with thesame object and effect should be treated in the same way; andwarranties should be removed from English jurisprudence.

4.14 They described our proposals on warranties as “disappointing” and thought theydid not go far enough. Jardine Lloyd Thompson also agreed that terms that havea similar effect, such as conditions precedent, should be regulated in the sameway. Other respondents, however, did not specifically address the issue.

THE LIMITED EFFECT OF OUR PROPOSALS ON CONSUMER POLICIES 4.15 It is worth pointing out that for consumers our proposals would only apply where

an insurer used a warranty in the strict sense. Their main effect would be toprevent insurers from using such a term to reject a claim that was not causallyconnected to the breach.

4.16 However, the use of strict warranties in consumer contracts is rare. In our surveyof 50 FOS cases concerned with policy terms, we did not find any consumerpolicies that used strict warranties in this way. Many insurers confirmed thisposition in their responses. Furthermore, in almost all cases in which an insurerwished to use a warranty, it would be easy enough for the insurer to re-write theterm as a temporal exclusion or definition of the risk.

4.17 Effectively, our proposals were a tidying up exercise, in which the more extremeprovisions of the Marine Insurance Act 1906 would be repealed. The purpose ofour reform was to resolve inconsistencies in the law rather than to address asubstantive injustice. In the absence of a widespread or a specific consumerproblem, our current view is that this would be done more effectively alongsidethe business provisions.

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THE IMPORTANCE OF THE UTCCR 4.18 We thought that the Unfair Terms in Consumer Contracts Regulations 1999

(UTCCR) should remain consumers’ main substantive protection against unfairterms. Professors Rob Merkin and John Lowry criticised this on the grounds thatthe Regulations “do not apply to terms which define the main subject matter ofthe contract, so risk definition is unaffected”.

4.19 In the Consultation Paper we said that the UTCCR had surprisingly little impacton the insurance industry. This was partly because the Regulations are not wellunderstood. In particular, there were misunderstandings about which terms areexempt from review because they are “core terms”, that is they define the mainsubject matter of the contract or the price.

4.20 In 2005 the two Law Commissions published a joint report and draft Bill on UnfairContract Terms.28 The Bill includes three separate regimes: for consumers, forsmall businesses and for all businesses. The small and general businesssections do not apply to insurance. However, the consumer section does. It is notintended to make substantive changes, but rewrites the effect of the UTCCR inclearer and more accessible terms.

4.21 In particular, the draft Bill gives a clearer definition of which core terms areexempt from review. It states explicitly that in order for a term to be exempt fromreview it must be “transparent”, that is expressed in reasonably plain language,legible, presented clearly, and readily available. A term that defines the mainsubject matter of the contract must also be substantially the same as theconsumer reasonably expected.29 The report has been accepted in principle andis awaiting Parliamentary time.

4.22 If Parliament considers a Consumer Insurance Bill before the Bill on UnfairContract Terms, it would be possible to copy across the provisions in our UnfairTerms Bill that apply to insurance.

4.23 We do not think that this would involve a substantive change. The FOS regularlyreviews consumer policy terms for fairness, as did its predecessor, the InsuranceOmbudsman Bureau (IOB). In 1990, the IOB said it would apply the spirit of theUnfair Contract Terms Act 1977. The FOS continues this tradition, applying boththe spirit of the 1977 Act, the UTCCR and the FSA rules requiring significant orunusual terms to be brought to the consumer’s attention. In the rare cases inwhich consumers choose to go to court, the courts may also review terms forfairness under the UTCCR.

4.24 However, the law in this area is not always well understood. We will give furtherconsideration to whether implementing the relevant consumer sections of ourdraft Bill on Unfair Contract Terms in an insurance context would be helpful bymaking the law clearer and more explicit, or whether the current provisions aresufficient.

28 Unfair Terms in Contracts (2005), Law Com No 292; Scot Law Com No 199.29 Draft Bill, clauses 4(2) and 14(3).

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PART 5PRE-CONTRACT INFORMATION ANDINTERMEDIARIES

THE PROBLEM 5.1 Where insurance is arranged through an intermediary, the intermediary may

introduce inaccuracies into the pre-contract information the consumer is requiredto provide to the insurer. An agent may, for example, act fraudulently to obtain acommission by deliberately altering the information the consumer has provided.Or the agent may give wrong advice about what the insurer wants to know, eitherdeliberately or negligently. For example, in our study of FOS cases, a consumerwho applied for critical illness insurance was required to complete a proposalform asking whether she suffered from asthma. The agent wrongly told theconsumer that she did not need to mention mild asthma because the insurer onlywanted to know about serious asthma.

5.2 Under current law, the crucial issue is whether the intermediary is considered toact for the insurer or for the consumer.

(1) If the intermediary acts for the consumer, the intermediary’s actions andstate of mind are imputed to the consumer. This means that where anagent has deliberately falsified information, the insurer is entitled to treatthe consumer as if they had made a deliberate misrepresentation. Theinsurer may avoid the policy and deny all claims (even where theconsumer is innocent of all wrongdoing). Similarly, if the intermediary hasgiven negligent advice, the consumer would be treated as if they hadmade a negligent misrepresentation (even if the consumer actedreasonably in relying on the advice). In both circumstances the consumermay bring a separate action against the intermediary for compensation.

(2) If the intermediary is taken to act for the insurer, the intermediary’sactions are imputed to the insurer. Where a consumer has acted honestlyand reasonably, the insurer would be required to pay the claim, and bringits own action against the intermediary.

5.3 It is therefore important to establish whether an intermediary who conveysinformation to an insurer is acting for the consumer or for the insurer. Weconcluded that the law governing these arrangements was complex, confusingand uncertain. It is difficult to apply cases dating from the early twentiethcentury30 to a modern, dynamic market place (with, for example, increasing useof multi-ties, panels and “white labelling”, where insurance is branded with thedistributor’s name). We thought there was a need to clarify the law in this area.

30 See, for example, Biggar v Rock Life Assurance Co [1902] 1 KB 516 and NewsholmeBrothers v Road Transport [1929] 2 KB 356.

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5.4 As a general principle, we thought that an intermediary should be regarded asacting for an insurer for the purpose of obtaining pre-contract information, unlessit is clearly an independent intermediary acting on the insured’s behalf. We thenwent on to discuss how an “independent intermediary” should be defined. Wesuggested adopting the same approach as the Insurance Mediation Directive,which uses the concept of a “fair analysis” of the market.

5.5 These proposals proved to be controversial in three areas:

(1) Some respondents disagreed that the law was uncertain, and saw noneed for reform.

(2) Some queried the principle that intermediaries should be considered toact for insurers unless they were clearly independent.

(3) Many expressed concern over our definition of “independence”.

Below we consider each element in turn.

IS THERE A NEED FOR REFORM?

“The law is sufficiently clear” 5.6 Just over a quarter of respondents (including 13 insurers) considered that the law

was sufficiently clear, or did not cause enough problems to justify reform. Most ofthose who described the law as clear thought that it was generally accepted thatintermediaries act for consumers in providing information. As Friends Providentput it:

There is no uncertainty in the current law that where the intermediarycompletes this process [collating information on a proposal] he isacting for the customer. To suggest otherwise makes the intermediaryand the provider essentially the same person, which defeats thewhole point of the process. Furthermore it is invariably the practice ofmost Insurers to make abundantly clear both the need for accuratedisclosure and the fact that agents act for the customer and not theProvider for this purpose. [Friends Provident]

5.7 The ABI said:

The law is very clear in this area and if properly applied, should notcause the confusion feared by the Law Commission. In any event, theperceived problems identified can be dealt with through the existingregulatory framework provided by the FSA and the FOS. [ABI]

5.8 The ABI argued that the relationship depended on the Terms of BusinessAgreements (“TOBAs”) between insurer and intermediary. It was “common forsuch agreements to state categorically that the intermediary acts on behalf of theinsured on all matters except in relation to the collection of premiums where theyact on behalf of the insurer”. The ABI appeared to suggest that the courts wouldconsider such a statement to be definitive. Where it existed, the insurer wouldautomatically be considered to be the consumer’s agent. Several insurers agreedwith the ABI on this point.

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5.9 Aviva said that the distinction should depend on how the intermediary isauthorised: “all directly authorised intermediaries should be the agent of theconsumer, and all appointed representatives should be agent of the insurer”.Aviva also said that the law should remain as it is, indicating that Aviva considersthis to be the current law.

Why we thought the law was unclear 5.10 Given the views expressed it may be helpful to explain why we argued that the

law in this area was unclear. Our conclusions are set out in Part 9 of theConsultation Paper and may be summarised as follows:

(1) In receiving pre-contract information, intermediaries will generally beconsidered to act for the insurer if they are:

(a) the insurer’s employee;

(b) the insurer’s appointed representative;31

(c) given binding authority to issue cover;32 or

(d) sent by the insurer to solicit business.33

(2) Intermediaries will generally be considered to act for the policyholder ifthey:

(a) are not paid a commission by the insurer;

(b) are Lloyd’s brokers;34 or

(c) undertake to give the consumer independent advice (even if theinsurer does pay them a commission).35

(3) If an independently authorised intermediary sells the product of only oneinsurer, without the authority to bind cover, the legal position is less clear.The FOS told us that ombudsmen often consider such agents to beacting for the insurer. This was borne out in our survey of cases, in whichwe noted that insurers usually accepted the FOS approach. Undercurrent law, we think that insurers may struggle to argue before thecourts that such an agent does not act for them.

31 The Financial Services and Markets Act 2000, s 39(3) states that the principal isresponsible for the intermediary’s acts or omissions. Although technically this section onlyapplies to regulatory issues, we think that industry practice suggests that insurers giveimplied authority to their appointed representatives to receive pre-contract information.

32 See Stockton v Mason [1978] 2 Lloyd’s Rep 430 and Woolcott v Excess Insurance Co Ltd[1979] 1 Lloyd’s Rep 231.

33 See MacGillivray at para 18-6. This received judicial support in Winter v Irish LifeAssurance [1995] 2 Lloyd’s Rep 274 and Arif v Excess Insurance Group 1986 SC 317.

34 Roberts v Plaisted [1989] 2 Lloyd’s Rep 341.35 See Winter v Irish Life Assurance [1995] 2 Lloyd’s Rep 274 and Arif v Excess Insurance

Group 1986 SC 317.

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(4) The most controversial area is where the intermediary sells the productsof a limited number of insurers (and is paid a commission to do so)without giving the consumer independent advice. This is a fairly commonsituation, and we do not know what a court would decide. Under basicprinciples of agency law, the issue would depend on whether the insureracted in such a way as to give the agent “ostensible authority” to collectpre-contract information from the consumer. This in turn would beinfluenced by what a consumer would reasonably understand from anywritten material the insurer allowed the intermediary to give to theconsumer.

5.11 We think insurers would be poorly advised to rely exclusively on a statementwithin their TOBAs that the intermediary acts for the consumer. Even whenlooking at the issue of express authority, the court would need to construe theagreement as a whole, not simply rely on one statement. And in the absence ofexpress authority, an intermediary may still be held to be the insurer’s agent if ithas implied or ostensible authority from the insurer.

5.12 In practice, we were not able to find a single court or FOS decision in which theinsurer had relied on their TOBA, or indeed revealed the TOBA to the court orombudsman. This makes it difficult to be certain how much emphasis a courtwould be prepared to place on it.

Do consumers understand the legal position? 5.13 Some insurers said consumers generally understood the legal position:

We therefore dispute that there is any misunderstanding in the mindof the customer about the role the intermediary plays in collecting thisinformation. [Friends Provident]

5.14 However, consumer groups disagreed. The Multiple Sclerosis Society thoughtthat intermediaries need to make their status clear to the assured. The NationalConsumer Council (NCC) wrote:

We suspect that many consumers do not always realise that they aredealing with someone who is an intermediary rather than an insurer.[NCC]

5.15 The Financial Services Consumer Panel stated that:

Many insureds simply see the intermediary “as part of the industry”.They do not understand that the intermediary acts for them and notfor the insurer. [Financial Services Consumer Panel]

5.16 In responding to our Issues Paper, the FOS said:

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The applicant for insurance is frequently unaware that the insuranceintermediary is acting as their agent in this part of the overall processof applying for and receiving insurance cover. Indeed, it appears fromthe experience of the Financial Ombudsman Service that mostconsumers applying for insurance cover believe that the intermediaryis acting as the seller of the insurance policy (and they do notconsider whether they act on behalf of the insurance company or ontheir own account). The exception is where the intermediary isexpressly offering a service that reviews insurers and offers thecheapest or most suitable policy.36 [FOS]

5.17 We note that the FSA has drawn attention to the problems facing commercialcustomers in this area, stating that “a key concern is the lack of clarity aboutwhether the intermediary is acting for the customer, for the insurer or, in somecases, both”.37 It is likely that consumers are similarly unclear about the status ofthe intermediary they are using.

The ABI Guidance on long-term protection policies 5.18 As previously discussed, in January 2008 the ABI issued guidance to the

protection industry about how to deal with issues of non-disclosure. This states:

Whether an intermediary was acting as an insurer’s agent in atransaction will depend on the facts and circumstances of eachcase.38

5.19 This highlights (correctly, in our view) that there is currently no single test todetermine who an insurer is acting for. It is not enough, for example, just to lookat whether the intermediary is independently authorised or whether it is deemedto be the consumer’s agent in the insurer’s TOBA. However, the statement is oflimited practical value. It would be helpful to know what facts and circumstancesare relevant.

36 Response by Peter Hinchliffe sent on 22 January 2007, and quoted in the ConsultationPaper at p 252.

37 FSA, Transparency, Disclosure and Conflicts of Interest in the Commercial InsuranceMarket, DP 08/2, March 2008. See also the research by CRA International, CommercialInsurance Commission disclosure: Market Failure Analysis and High Level Cost BenefitAnalysis, December 2007, which showed confusion among commercial customers overwhether their intermediaries provided a fair analysis of the market.

38 Para 3.4.2. The ABI Guidance is discussed in this paper at paras 2.68 to 2.71 and paras2.147 to 2.151.

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Is there a need to clarify the law? Overview 5.20 Whilst the law may be clear at either extreme (such as authorised representatives

or fully independent advisors) there are a wide range of relationships where thelegal position is difficult to ascertain. Insurers appear to over-estimate the extentto which intermediaries would be taken to act for the consumer in providing pre-contract information. This is true especially when intermediaries areindependently authorised but sell a limited range of products on a non-advisedbasis. Similarly, consumers may under-estimate the extent to which they areresponsible for the actions of an intermediary. Many would be surprised todiscover that an insurer is entitled to treat an honest consumer in the same wayas a dishonest consumer because the intermediary has altered informationwithout their knowledge.

5.21 Our aim is to provide clear, accessible law on consumers’ duties to provide pre-contract information and insurers’ remedies when they do not. Rules need to besufficiently flexible to meet developing business practices. However, theresponses suggest that it would be helpful if the law provided more guidance thanthat currently derived from the cases, several of which were decided early lastcentury.

SHOULD INTERMEDIARIES BE TAKEN TO ACT FOR INSURERS UNLESSTHEY ARE CLEARLY INDEPENDENT?

5.22 As a basic principle, we thought that responsibility for misconduct byintermediaries should be placed on the party best able to prevent thatmisconduct.

5.23 We noted that most consumers dealt with intermediaries only rarely, and were ina poor position to influence the intermediary’s business practice. This wasparticularly true in the protection market. Consumers would only know that amisrepresentation had been made when they came to make a claim, which maybe many years later (and often after the fraudulent agent had left the firm).Recently bereaved or seriously ill consumers were rarely in a strong position tobring an action against the intermediary, and may decide not to litigate when thecircumstances merited it.

5.24 We thought that insurers were better able to monitor and discipline theintermediaries they sold through. We were particularly concerned about the ruleallowing insurers to avoid policies whenever the intermediary has falsifiedinformation. As noted in Part 2, avoidance is a penal remedy that over-compensates insurers for the loss they have suffered. It sets up a perverseincentive, whereby the insurer may make a greater profit from a fraudulentintermediary than from an honest one.39 Although we did not think that an insurerwould ever encourage such behaviour, we thought that the current law may notdo enough to encourage insurers to take swift and firm action against dishonestintermediaries.

39 See the example in the Consultation Paper p 254.

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5.25 We noted that in 1957 the Law Reform Committee recommended thatintermediaries should always be regarded as the insurer’s agent in receiving pre-contract information. However, we did not go this far. We thought that anabsolute rule of this kind would have a deleterious effect on small independentbrokers. Insurers would find it hard to police a large number of small independentfirms and may refuse to deal with such firms.

5.26 We therefore provisionally proposed a compromise: an intermediary should beregarded as acting for an insurer for the purposes of obtaining pre-contractinformation, unless it is clearly an independent intermediary acting on theinsured’s behalf (CP para 12.70).

5.27 This was controversial. Of the 67 consultees addressing this question, just overhalf (36) disagreed with our proposal.

Arguments that our proposal was too timid 5.28 Three consultees thought we were wrong to reject the straightforward solution put

forward by the Law Reform Committee in 1957. They argued that intermediariesshould always be considered as the insurer’s agent for disclosure purposes.

5.29 Professors Robert Merkin and John Lowry addressed this issue at length:

If the brokers have asked the right questions, including a sweepingquestion, the assured will either tell the truth or make falsestatements. Given that the information-gathering exercise has to takeplace as between the assured and the broker, it is not immediatelyapparent why the assured should bear the risk of that process beingimproperly replicated as between broker and insurers. [ProfessorsMerkin and Lowry]

5.30 It was argued that the intermediary’s role changes from function to function.Intermediaries may give the consumer independent advice, but their role changeswhen it comes to completing the form and concluding the contract. Insurersprovide the forms and pay intermediaries for this work, so should be consideredto act for the insurer while they do so. Lord Justice Rix wrote:

Typically the broker will search the market on price; but what doesthat tell you about his role for the purposes of pre-contractinformation? Particularly in the field of consumer insurance, I suspectthat when once the broker finds a price acceptable to the insured(based on standard information from the assured), the hard work ofthe proposal form begins from there, with only one insurer in mind atthat stage. Moreover, everything the broker does is done behind thescenes, so far as the assured is concerned. In these circumstances, Iwould prefer a functional rule, which reflects that brokers and insurersare part of the same industry to which the assured is not party. [LordJustice Rix]

5.31 Age Concern thought that intermediaries who are paid commission by the insurershould always be deemed to be the insurer’s agent. Only those who are paiddirectly and solely by the consumer should be their agent.

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Arguments that our proposal was too radical 5.32 Most insurers, however, thought that our proposal went too far in making insurers

responsible for intermediaries. The main argument was that this would be costlyand disruptive to the market. The Chartered Insurance Institute, for example,argued that a change in agency law “would come with huge implications onunderwriting and broking practices, as well as insurer internal systems andcontrols”. Aegon UK commented that

Were this proposal to come into force there would need to bewholesale changes to the compliance regime and intermediarieswould be potentially left with the unsatisfactory situation of havingseveral insurers requiring to have control over theircompliance/training etc. [Aegon UK]

5.33 The ABI thought that it would add to costs:

Should the Law Commission’s proposals be adopted, revisions ofTerms of Business Agreements may be necessary at great expenseto the industry. Further, there may well be the need for a completeoverhaul of insurers’ intermediary application/assessment processes,again at substantial cost. [ABI]

The ABI thought that it would lead insurers to restrict those firms with whom theytraded, making it harder for new firms to enter the market.

5.34 Respondents suggested that in practice insurers were often not able to monitor orcontrol their agents, especially large composites who have thousands ofagreements in place. The Lloyd’s Market Association commented that ourproposal would render the insurer liable for the acts of intermediaries, evenwhere that intermediary has not entered into a TOBA with the insurer. Withoutsuch an agreement, the insurer would have no contractual basis for suing theintermediary to recover the cost of the paid claim.

5.35 The Institute of Insurance Brokers feared that insurers would seek an indemnityfrom the broker for instances where the broker was deemed to be acting for themand threaten to terminate the agency agreement if the intermediary did notprovide the indemnity.

DEFINING “INDEPENDENCE”: THE “FAIR ANALYSIS” TEST 5.36 In the Consultation Paper we noted that under the Insurance Mediation Directive,

intermediaries must tell their customers whether their advice is based on “a fairanalysis” of the market. We saw advantages in using the same test to definewhether an intermediary is giving the policyholder independent advice. Thedistinction already exists; and consumers must already be given this information.We thought it would be confusing for consumers to receive two separatestatements, one about a fair analysis and one about whether the intermediary isacting for them. We therefore asked whether the test to determine whether anintermediary is independent should depend on whether the intermediary conducts“a fair analysis” as defined by the Insurance Mediation Directive (CP para 12.71).

5.37 Most people thought it should not. Of the 64 consultees who gave their views,almost two thirds said no.

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Uncertainty over “fair analysis” 5.38 The main argument against using a fair analysis test was that it would be

unpredictable. Despite the fact that intermediaries are compelled to tell potentialpolicyholders whether they offer a fair market analysis, many of those working inthe market appear to be genuinely uncertain about what it means. They aretherefore reluctant to extend its influence further.

5.39 The Directive defines a fair analysis in the following terms:

When the insurance intermediary informs the customer that he giveshis advice on the basis of a fair analysis, he is obliged to give thatadvice on the basis of an analysis of a sufficiently large number ofinsurance contracts available on the market, to enable him to make arecommendation, in accordance with professional criteria, regardingwhich insurance contract would be adequate to meet the customer’sneeds. 40

5.40 The test is therefore framed in terms of high-level principle. At first sight, it doesnot appear to be unduly onerous. It does not require an intermediary torecommend the best policy, merely one that is “adequate”. It is intended that thedetails would be provided by professional bodies setting out professional criteria.

5.41 However, it is clear that the test has no generally agreed meaning. Mostrespondents thought that offering the products of only one insurer would not be afair analysis, and searching the whole market would be a fair analysis. But therewas concern over where the dividing line should be drawn, particularly whereintermediaries arranged policies from a limited panel of insurers.

5.42 The solicitors Hill Dickinson pointed out that what would be reasonable for onegeographical area or specialist market might be completely inadequate inanother. Consultees felt that the test would not reflect the complexity of thedifferent products and business arrangements. Further questions were alsoasked. How often does the intermediary have to review the list of insurers that itrecommends? What about renewals where there is a fair analysis on firstplacement but no analysis when the policy is renewed? Even intermediariesthemselves did not have clear answers to these questions.

5.43 The Institute of Insurance Brokers said “few brokers use the whole marketbecause they cannot enter into TOBAs with every provider or do not want torecommend insurers with low solvency ratings or restrictive policy wordings orpoor service standards”. It would, however, not be clear from the test proposedhow many providers they would need to have TOBAs with in order to be deemedto be making a “fair market analysis”.

5.44 The fair analysis test has implications far beyond issues of pre-contractinformation. Yet there appears to be general confusion about the standard ofadvice the test requires.

40 Directive 2002/92/EC, Art 12.2.

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Undertake to conduct a fair analysis, or actually conduct a fair analysis? 5.45 The way the Consultation Paper question was phrased suggested that the test

should depend on whether the intermediary conducts a fair analysis. We did notsay it would depend on whether the intermediary undertakes to provide a fairanalysis. It was pointed out that an insurer could find itself responsible for anintermediary’s actions where the intermediary informed the consumer that it willoffer advice on the basis of a fair analysis of the market, but then failed to live upto its promise.

5.46 This raised criticism, especially from insurers, that they will “unwittingly becomeresponsible for intermediaries that fail to search a sufficiently large number ofinsurers through negligence or laziness” (Keoghs). The British Insurance LawAssociation, Aegon UK, the Group Risk Development Goup, Swiss Re and Royal& SunAlliance all questioned how assureds seeking to make a claim or insurersseeking to defend one would know whether the intermediary actually did carry outa fair analysis. BILA pointed out that neither party could prove a case without theco-operation of the intermediary. The Law Reform Committee of the Bar Councilechoed the comments. They pointed out that the facts are almost exclusively inthe possession of the intermediary.

5.47 On reflection, we accept this was an error. If we were to use this test it wouldhave to depend on what the intermediary informed the consumer it would do, asrequired under FSA rules. If an intermediary undertook to provide independentadvice but then failed to do so, it would still be the consumer’s agent - albeit onethat was in breach of its duty to the consumer.

5.48 However, some insurers also pointed out problems with the “undertake toconduct a fair analysis” test. The result, they argued, was that if an intermediaryfails (whether deliberately or not) to tell a consumer that it has carried out a fairmarket analysis, that intermediary will be deemed to be the agent of the insurerfor the purposes of passing on pre-contractual information. The Lloyd’s MarketAssociation thought that this would render the insurer liable for the acts ofintermediaries, even where that intermediary has not entered into a TOBA withthe insurer.

The independent agent given specific instructions 5.49 It was pointed out that a policyholder may approach an independent intermediary

with specific instructions, and without requesting a recommendation. Arthur JGallagher raised this point saying that “if an assured instructs a broker to seekthe terms of one insurer that does not make the broker an agent of that insurer”.

5.50 This may happen, especially with renewals. A consumer may initially approachan independent intermediary for advice, but then decide to stay with the originalinsurer (perhaps because a claim is in hand). The consumer may tell theintermediary to renew the policy without the intermediary having provided furtheradvice. This would not necessarily make the intermediary the insurer’s agent.

The consumer view 5.51 Several consumer organisations criticised our approach on the basis that it will

not necessarily alert policyholders to the fact that the intermediary is working forthem and not for the insurer.

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5.52 The Financial Services Consumer Panel put it as follows:

The Panel is ... concerned that the mere requirement in the FSARules that a proposer be informed that the intermediary conducts a‘fair analysis’ is insufficient, without more, to make the proposeraware that the intermediary is in fact acting for the proposer for thepurposes of obtaining pre-contractual information. [Financial ServicesConsumer Panel]

Alternative proposals 5.53 Several consultees put forward alternative ways of solving the problem of working

out who an intermediary is acting for when passing pre-contractual information toinsurers:

(1) About a fifth of consultees felt that the issue would be more suitable forregulation than for legislation. The point was strongly made by the ABI.Insurers and brokers were concerned that legislation would prevent newmethods of selling being developed.

(2) Several consultees (including brokers, lawyers and insurers) suggestedthat intermediaries should at the outset make a declaration to theconsumer stating for whom they are acting. These consultees felt thatour arguments about the effectiveness of warning notices and the risks ofdamaging brokers’ reputations (CP para 10.19) were not persuasive.

(3) Geoffrey Lloyd and Derrick Cole thought that where there is a single tie,the intermediary should be deemed to act for that insurer. In all otherinstances the intermediary should be deemed to act for the consumer.

THE WAY FORWARD: OVERVIEW 5.54 It is important to stress that this discussion is not concerned with the status of

insurance intermediaries generally. It addresses very specific issues: whathappens when a consumer has behaved honestly and reasonably in answeringan insurer’s questions, but the insurer has nevertheless been misled by theintermediary’s dishonesty or negligence? Should the insurer pay the claim, andpursue a remedy against the intermediary? Or should the insurer be entitled toavoid the policy, or pay only a proportionate settlement, and leave the consumerto pursue the intermediary?

5.55 The issue also arises where the intermediary has been dishonest in falsifyinginformation, and the consumer has been negligent in failing to notice (forexample, in not reading the form sufficiently carefully before signing it). In thesecircumstances, should the insurer be entitled to avoid the claim (on the groundsthat the consumer is imputed with the intermediary’s dishonesty) or should theinsurer pay a proportionate settlement?

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The practical effect 5.56 Some respondents thought that our proposals were more far-reaching than this,

and would have changed the agency status of intermediaries for other purposes.It was thought to be “the thin end of the wedge”, leading to other changes inregulatory status. This was not our intention. We do not think that change in thisparticular area would lead to the widespread changes in internal systems andcontrols that some suggested.

5.57 The issue of intermediary misrepresentation does arise in practice, but should notbe exaggerated. In our survey of FOS cases on non-disclosure, 13% of casesraised allegations that the fault lay with the intermediary, but not all theseallegations would be proved. We can understand the fear that change mayincrease costs. However, the industry also needs to be aware of the cost to itsreputation caused by the current situation. It is important that the rules are fairand seen to be fair, and do enough to encourage good practice.

5.58 If the industry is concerned about agent misrepresentation, there are targetedsolutions, which do not involve the insurer becoming intimately involved in theintermediary’s compliance processes. The most obvious is “tele-underwriting”.Here intermediaries do not take consumers through the proposal forms. Instead,consumers phone a call centre, in which the staff who ask the questions are notpaid commission based on the number of people who complete the process.

5.59 The Pricewaterhouse Cooper research submitted by the ABI noted an interestingstudy on this issue.41 It took a sample of cases in which consumers had beenguided though a form by a commission-based intermediary, and had raised nohealth problems. The consumers were then contacted by telephone by staff notpaid on a commission basis. In 75% of cases, the consumers mentionedsomething not raised on the form and in 25% of cases the issue was significant.The consumers had not changed: if they were lying they would have lied to thetelephone staff as well. The only difference was in the way the questions wereput. If this study is of general application, it raises serious concerns about theway that that the industry gathers information from consumers. It would suggestthat the current legal rules do not do enough to incentivise insurers orintermediaries to ask questions in a way designed to get the right information.

5.60 Clearly, the problem is difficult. As many respondents pointed out, there are noeasy solutions. However, if the rules are clarified to give the right incentives andprevent cases of apparent injustice, the industry as a whole will benefit.

No bright line test 5.61 In an ideal world, the issue of whom an intermediary is acting for would have a

simple straightforward answer. The many detailed arguments we receivedsuggest that we do not live in such an ideal world. The only simple solution wouldbe to adopt the 1957 test, and state that intermediaries always acted for theinsurer in receiving pre-contract information. However, we thought this woulddamage small, independent intermediaries.41 “Clean” applications? How clean?, MorganAsh, cited by PricewaterhouseCooper, The

Financial Impact of the Law Commission’s Review of Insurance Contract Law, ABIResearch Paper 5, at p 49.

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5.62 Without such a radical change to the law, the issue will remain complex. It wouldnot be possible to say that any given intermediary always acts for one side or theother in receiving pre-contract information. Intermediaries stand between insurersand consumers and often change hats during the process. Take the case of anindependent intermediary with authority to bind the insurer to temporary cover butnot the main cover. Under current law, the intermediary acts for the insurer inreceiving information in respect of the temporary cover but not in respect of themain cover.

5.63 Another example would be where an independent intermediary completes apaper proposal form in face to face discussion with the consumer and is thenpaid by the insurer to transcribe the results onto the insurer’s system. Even if theintermediary acts for the consumer in the face to face discussion, we think theyact for the insurer while transcribing. The insurer would not be able to refuse aclaim because errors occurred in the transcription process.

5.64 The responses we have received suggest that it is not possible to impose asingle test to decide whether an intermediary is independent. Technology ischanging the way that insurance is distributed and sold. Although there is a needfor greater clarity, we do not wish to restrict product development or placeregulatory obligations on parties who are not in a position to enforce them.

Is it possible to produce statutory or non-statutory guidance? 5.65 We have considered whether it is possible to set out the current law with greater

precision.

5.66 In law some factors are decisive. For example, an intermediary with authority tobind to cover will always be taken to act for the insurer. Although the point is notbeyond all argument, we also think there is general agreement that an insurer’sappointed representative will also be regarded as the insurer’s agent. Bycontrast, if an intermediary is only paid by the consumer, and does not receive afee or commission from the insurer, it will be taken to act for the consumer.

5.67 Other factors are persuasive. They need to be taken into account, though will notnecessarily determine the issue if other factors point in the opposite direction.Persuasive factors that may indicate that an intermediary acts for the consumerare that:

(1) The consumer pays the intermediary a fee, even if the insurer pays a feeas well. The greater the amount of the intermediary’s remuneration thatcomes from the consumer, and the more open and transparent thecommission arrangements, the greater the likelihood that theintermediary acts for the consumer;

(2) The intermediary undertakes to carry out a fair market analysis;

(3) The intermediary would normally undertake to carry out a fair marketanalysis but is instructed by the consumer to contract with a particularinsurer.

(4) The intermediary makes a declaration stating that it does not act for theinsurer.

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5.68 Persuasive factors that indicate that an intermediary acts for the insurer are that:

(1) The intermediary has a ‘terms of business agreement’ with the insurer.This would not be sufficient on its own to establish that the intermediaryacts for the insurer but would indicate that there is a connection;

(2) The intermediary only ever contracts with one insurer or a limited numberof insurers. What constitutes a ‘limited number’ will depend on theproduct and the market;

(3) The consumer is given the impression that the intermediary and theinsurer are part of the same brand, for example, if the intermediary usesstationery or a website that is branded by the insurer, or vice versa.

5.69 We will give further thought to whether guidance along these lines would be ahelpful clarification of the current law, particularly for insurers, the FOS and thecourts. We will also consider whether guidance of this sort should take statutoryor some other form and we shall be seeking views on this from interested parties.

5.70 We accept that such guidance would be fluid and would not always give an easyanswer in each case. This is the inevitable consequence if we reject a bright linetest in favour of a more nuanced and flexible approach, which takes into accountall the circumstances of the relationships between intermediary, insurer andconsumer.

Joint complaints 5.71 A major problem with the current position is that consumers must make two

separate complaints to the FOS, one against the insurer and one against theintermediary. This is time consuming and difficult, and often occurs whenconsumers are particularly vulnerable, because, for example, they are critically illor recently bereaved. We noted cases in which consumers had pursuedcomplaints to a final ombudsman decision over the course of months or years, tobe told that they must start again at the beginning against a financial adviser.

5.72 In the Consultation Paper we expressed the hope that “more could be done toassist consumers to bring complaints against the correct organisation, ifnecessary considering complaints in tandem where the status of the agent isdisputed”.42

5.73 Where a complaint or case involves both intermediary and insurer together, theissue of who the intermediary is acting for becomes much less important. In anyevent the intermediary pays to the full extent of the claim.

42 Para 9.124.

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INTERMEDIARIES NOT REGULATED BY THE FSA 5.74 In the Consultation Paper, we noted that some intermediaries were not regulated

by the FSA. An example is where a consumer buys a car using a financeagreement and the car retailer sells the consumer insurance to cover the futurepayments under the finance agreement. We asked whether any additionalprotection was necessary for the consumer buying from these intermediaries (CPpara 12.72).

5.75 Of the 45 consultees who gave their views on this question, the majority (71%)said that no additional protection was needed. Most thought the issue should beleft to the FSA to monitor. The fact that the FSA announced in June 2007 that itwould regulate travel agents selling travel insurance was quoted as evidence thatthe FSA will extend its jurisdiction when it feels that there is a problem. TheNational Consumer Council agreed that the FSA should continue to monitor themarket.

5.76 There appears to be general agreement that this issue does not need to beconsidered in the course of our review of insurance contract law.

THE NEWSHOLME CASE 5.77 In the Consultation Paper, we drew attention to the case of Newsholme Brothers

v Road Transport and General Insurance Co Ltd.43 This dates from 1929, andsuggests that even if an intermediary is an agent of the insurer, it should beconsidered to be an agent of the insured for the purposes of completing aproposal form. We said that there was uncertainty over whether the caseremained good law.

Transferred agency 5.78 Insurers’ employees and authorised representatives often give consumers advice

about completing proposal forms in the course of their duties. We thought that thesuggestion in Newsholme that when they do so they become the consumer’sagent made little sense in a contemporary environment. We provisionallyproposed that the rule in Newsholme should be overturned, so that anintermediary who would normally be regarded as acting for the insurer inobtaining pre-contract information should remain the insurer’s agent whilecompleting a proposal form (CP para 12.73).

5.79 Most people agreed with us, though some insurers thought the law should be leftas it is. The ABI said that the law in this area was clear and should not be subjectto change.

43 [1929] 2 KB 356.

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Signature 5.80 In Newsholme the policyholder had signed a basis of the contract clause. The

decision could be interpreted as saying that a policyholder is bound by theirsignature on the proposal form, no matter what the circumstances. A problemmight arise when a consumer has signed a form without being aware that anintermediary has made a particular statement on it. If the consumer would haveknown that the statement was untrue had they known that it was there, there isan argument that they could be deemed to have made a deliberatemisrepresentation, even though they were guilty of nothing more thancarelessness.

5.81 We provisionally proposed that a consumer insured’s signature on a proposalform that has been completed incorrectly by a third person should not beregarded as conclusive evidence that the insured knew of or adopted what waswritten on the form (CP para 12.74).

5.82 Although most people agreed, many thought that a provision of this sort wouldsend the wrong message to consumers. Of the 61 consultees providing views,just over a quarter thought that the proposal would encourage recklessbehaviour. They wanted a clearer signal to be sent to consumers that they musttake responsibility for their actions. Some thought that the proposal would meanthat they would no longer be able to rely on anything that the consumer wrote inthe form as being accurate.

Is Newsholme good law? 5.83 There is a strong argument that Newsholme is no longer good law.44 If the

“transferred agency” rule were to be applied, it would mean that if a member ofan insurer’s call centre staff made a mistake, the consumer would be heldresponsible for it. We have not found a FOS case or contemporary court case inwhich an insurer attempted to run such an argument, and we think that the courtswould give it short shrift if it did. Furthermore the argument that a policyholder isbound by their signature on a proposal form, no matter what the circumstances,is addressed by our proposals on basis of the contract clauses.

5.84 If the courts would no longer attempt to apply the Newsholme rule, then theremay be no need for specific legislative provisions to remove it.

MARINE INSURANCE ACT 1906, SECTION 19 5.85 Section 19 of the Marine Insurance Act 1906 states that:

Subject to the provisions of the preceding section as to circumstanceswhich need not be disclosed, where an insurance is effected for theassured by an agent, the agent must disclose to the insurer –

44 See for example “Reform of Insurance Law: Intermediaries” (May 2007) 19 Insurance LawMonthly 1.

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(a) Every material circumstance which is known to himself, and anagent to insure is deemed to know every circumstance which inthe ordinary course of business ought to be known by, or to havebeen communicated to, him; and

(b) Every material circumstance which the assured is bound todisclose, unless it comes to his knowledge too late tocommunicate it to the agent.

5.86 Where the section is breached, the insurer has a right to avoid the policy againstthe policyholder.

5.87 Although in theory the section applies to consumer insurance, we have not foundany case in which the section has been applied in a consumer context. We askedwhether there was any reason to retain the two sub-sections for consumerinsurance (paras 12.75 and 12.76).

Respondent views 5.88 Most respondents confirmed that the section had never been used, and that the

issue was “largely academic”.

5.89 The ABI agreed that section 19(b) added little to an insurer’s existing remediesand was at odds with the FOS position. They also thought that if any insurerattempted to rely on section 19(a), the FOS would uphold the consumer’s claimand find that the insurer’s decision was unfair. It would also be contrary to theFSA’s initiative to Treat Customers Fairly. However, the ABI doubted that on itsown the issue was of sufficient practical importance to justify a change in the law.

Overview of responses 5.90 There is general agreement that section 19 has no practical effect, and any

insurer who attempted to rely on it against a consumer would not succeed. TheABI thought that the existence of this section would not justify reform on its own.However, if there is to be legislation, there appears to be general agreement thatsection 19 should be disapplied in a consumer context.

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PART 6ASSESSING THE COSTS AND BENEFITS OFREFORM

LONDON ECONOMICS REPORT 6.1 Our Consultation Paper included a preliminary investigation by London

Economics into the economic impact of our proposals relating to non-disclosureand misrepresentation in the consumer market for critical illness insurance. Wechose to examine this limited area of reform to consult on the methodology usedto assess the impact, rather than to consult on the impact itself. Nevertheless, weasked London Economics to produce as accurate results as were possible.

6.2 In assessing the costs and benefits of reform, London Economics dividedinsurers into Type 1 and Type 2 firms. Type 1 firms followed guidance from theFinancial Ombudsman Service (FOS) and the FSA regulations and hadinstitutionalised the Treating Customers Fairly initiative. On the other hand, Type2 firms had not done either of these things and would be forced to makewholesale changes to their underwriting practices. The model assumes that 93%of firms are Type 1.

6.3 London Economics concluded that the impact on those firms who already followFOS guidance (Type 1) would be minimal. Their estimate was that the costs oflaw reform for these firms would translate into no more than a 1 to 1.5% increasein premiums.45 This included extra administration costs. The costs of claimswould be relatively unaffected as firms continued to follow the good practiceexpected by the FOS and codified in our proposals. For firms that did not followthe FOS approach (Type 2), London Economics concluded that the impact wouldbe more dramatic. These firms would need to increase their premiums by 85% to95%. As it is unlikely that any consumer would pay such an increase, such firmswould either go out of business or would have to rewrite their business model tocomply with current FOS practice.

CONSULTEES’ RESPONSES 6.4 Relatively few consultees responded to the questions we posed about the

London Economics report methodology. Around 20 responded to each question.Many felt that the distinction between Type 1 and Type 2 firms was artificial. TheABI and Zurich Financial Services advised us that the vast majority of firms wereType 1 and that any analysis should concentrate only on them. Many consultees,however, referred us to the work that had been carried out byPricewaterhouseCoopers (PWC).

6.5 The ABI commissioned PWC to write a report on the financial impact of ourreview of insurance contract law. Their report covered all of our reforms, for asample of both commercial and personal lines. The report is detailed and a widerange of insurers have contributed to it.

45 Appendix B to Consultation Paper, table 17.

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6.6 PWC’s work on our consumer proposals shows that for consumer insurance theLaw Commissions’ proposals will have either no net financial impact on insurersor only a minimal impact.

6.7 We should, however, mention that PWC have assessed the costs and benefits ofsome reforms that were described in our issues papers but that, afterconsideration by the Law Commissions, were not proposed in the formalconsultation paper. For example, PWC’s data showed that insurers would suffera “high negative impact” if insurers were deemed to know details of previousapplications or claims by consumers within their firm and others within theirgroup. Likewise a presumption that insurers would seek information from thirdparties, such as doctors, was also assessed and felt to have a “high negativeimpact”. Neither of these proposals was in our Consultation Paper.

6.8 Despite this, PWC concluded that costs for general insurance personal lineswould be small.

The overall impact on general insurance personal lines is estimatedto be negative and of the order of £20 million to £80 million perannum for ongoing costs and negligible for one-off costs. Thisindicates that the costs of these implementations are likely to besmall.

One-off costs for these lines were estimated to be zero and on-going costs weresmall, estimated at 0.1% to 0.3% of premiums.

6.9 For life and protection lines PWC also estimated that one-off costs would be zeroand gave a range of on-going costs between zero and 4.3% depending on theapproach taken by insurers. Much of the estimated costs related to thesuggestion in Issues Paper 1 that there might be a three year non-contestibilityperiod for life and critical illness policies.

6.10 It is likely, therefore, that if our proposals as set out in our Consultation Paper hadbeen assessed the costs for consumer reform would have been assessed byPWC as lower still.

FUTURE WORK 6.11 We will be publishing an impact assessment with our final report and draft bill on

consumer insurance.

6.12 Collecting accurate data will be difficult. As PWC found, insurers do not currentlystore data on whether they have turned down a claim for negligent or innocentmisrepresentation. We would, however, be grateful for any extra help thatinsurers can give us in this regard.